01 April 2009

Restrictive covenants explained (Guernsey)

Restrictive covenants are terms contained in a contract of employment used by employers in an attempt to limit the actions of an employee both during the course of employment and once that employment has ended.

Restrictive covenants can be used to prevent employees from:

• poaching colleagues
• working for competitors
• soliciting or accepting client business for their own use and not that of the employer
• divulging confidential information.

How enforceable are they?

It is easier to enforce restrictive covenants during employment (because the employee’s duty to the employer is unquestionable during this time) than after employment but it is the restrictive covenants that take effect on and after the termination of employment employers will most often want to enforce.

When assessing the enforceability of post termination restrictive covenants the starting point is that in a free market economy all restraints of trade are contrary to public policy. Furthermore, where there is indecision as to the enforceability of a restrictive covenant, the Guernsey Court will apply what is known as the ‘contra proferentem’ rule which favours the employee.

However, post termination restrictive covenants will be enforceable where they:

1. safeguard a legitimate business interest; and
2. the scope of the restriction is reasonable in extent, duration and subject matter.

What are legitimate business interests?

It is not enough that an employer believes they are safeguarding a legitimate business interest; the Guernsey Court must recognise the interest as warranting protection. Examples of recognised legitimate business interests are:

• confidential information, trade secrets e.g. pricing structures, marketing strategies, client contact lists
• an employer’s staff base
• an employer’s client base (which can include prospective clients)
• trade connections and suppliers.

What is a reasonable scope of restriction?

Overall, reasonableness will depend on the nature of the employer’s business and the employee’s role within that business. If there was a dispute the Courts would take into account:

• The extent (geography) of the restriction - wide geographical provisions (e.g. covering England and Wales) in a contract governing employment in Guernsey are unlikely to be enforceable because of the relatively small size of the Island;
• The duration for which the restriction is sought to be applied – as a general rule the duration of a restrictive covenant will be considered reasonable if it is equivalent to the length of notice the employee is contractually entitled to. This will likely reflect the seniority of the employee and therefore the risk to the business of the employee breaching the covenant. However 12 months will usually be the maximum enforceable duration for senior employees in spite of their notice period; and
• The subject matter of the restriction - what is being restricted must be reasonable. Any irrelevant/unfair elements could render the entire clause unenforceable particularly if the restriction hasn’t been drafted well in the first instance

What are an employer’s remedies for breach of a restrictive covenant?

In the first instance, particularly where the breach has been discovered early on in the duration of the covenant, the employer should consider seeking an injunction against the ex employee to prohibit them from continuing the breach.

Employers can also consider seeking damages for the breach where there have been pecuniary losses suffered by the employer. However in reality damages can be difficult to obtain because it will often be difficult to a) evidence the breach and b) quantify the damage.

Employers should also beware of inadvertently drafting penalty clauses into contracts i.e. “if you breach this contract you will pay the employer £x”. Unless such a clause depicts a precisely calculated and genuine pre-estimate of loss, it will likely be unenforceable as a penalty clause.

What happens if the employer breaches the contract?

Where employment contracts are breached (deliberately or inadvertently) by the employer, it could have the effect of rendering restrictive covenants void/unenforceable. Wrongful dismissal (i.e. dismissing an employee without proper notice) will release that employee from his/her primary obligations under the contract, some of which may be held to be post termination restrictive covenants.

Where an employer fundamentally breached the contract, e.g. by refusing to pay an employee in accordance with the terms of the contract, the contract will likely be set aside, releasing the employee from all his/her obligations under it including any post termination restrictive covenants.

Where do you start?

When hiring new staff consider whether restrictive covenants are necessary at the outset. Consider whether, if this employee left your employment and began working for a competitor (or themselves) in the same line of business, it would pose a threat to your business?

Consider whether such a threat is a commercial threat to a legitimate business interest as described above.

Consider whether including the power to place the employee on gardening leave would offer adequate protection without including restrictive covenants in the contract of employment

Drafting tips

If, having considered the points above, you decide it is necessary to include post termination restrictive covenants in the contract, particular care should be taken when drafting the clauses. We would always advise seeking legal assistance when drafting such clauses in order to avoid problems and disputes in the future. In drafting restrictive covenants, consideration will need to be given to the scope and content of them in light of factors such as the employee’s:

• seniority
• responsibilities in the business
• influence over colleagues and clients
• contacts (clients and trade connections etc.).

The temptation to draft covenants which are too wide or too lengthy should be avoided and an employer should never use “standard form” restrictive covenants. Covenants should be employee and role specific.

Covenants should be drafted so that each part can be read independently of other parts, and the employer should ensure that they are contained in a document signed by the employee i.e. the employment contract itself and not a separate policy/ staff handbook. Finally, the employer should ensure that employees fully understand the restrictive covenants contained in their contracts, at the start of employment and upon termination.