Non-compete clauses in employment contracts are an increasingly common – and controversial – tool for businesses to protect themselves from the risk posed by departing employees. Contributors: Ben Smith and Dan Pollard, GQ Employment Law.
Such clauses typically prevent an employee from working for a competitor business (or setting up a competitor business) for a certain period following the end of their employment. Other post-termination restrictions might prevent departing employees from poaching clients or staff. Non-competes can be notoriously difficult to enforce and employers can incur significant legal costs attempting to enforce them. However, careful drafting can minimise this risk.
To be enforceable a court needs to find that the restriction is necessary to protect a legitimate business interest and goes no further than is reasonably necessary to protect that interest. Failing to consider the legitimate business interest at stake is a trap many employers fail into. Restrictions imposed solely to prevent competition will be void as an unlawful restraint on trade – despite what the term “non-competes” might suggest – so it is crucial to think about what interests you are protecting. Common examples of legitimate business interests are the protection of confidential information, client relationships or workforce stability.
To make matters worse, many non-competes are extremely poorly drafted. It is not uncommon to see examples that are obviously too broad to be enforceable – for example those which prevent a salesperson from soliciting any client irrespective of whether the salesperson personally dealt with that client. Others are not properly tailored to the realities of business – for example if a business receives its new work from third party referrers then a restriction on solicitation of clients is pointless.
A recent Court of Appeal case, Tilman v Egon Zehnder Limited, is an object lesson in the dangers of poorly drafted non-competes. The non-compete in question prevented the claimant, a senior employee at an international recruitment consultancy firm, from being “directly or indirectly engaged … concerned or interested in” any business which was in competition with the company for 6 months after her employment ended.
When the employee left the business to join a competitor, the company attempted to enforce the non-compete but the courts found that it was void. This was because the words “interested in” included owning shares – even a single share – and this was an overly broad restriction on the employee which could not be enforced. The restriction should have, but did not, contain the customary “saving” which permits the holding of shares – typically 1-5% of the shares in listed companies.
Perhaps the most consequential aspect of the decision is the Court of Appeal’s approach to the severability of post-termination restrictions. It is sometimes thought that judges have an unfettered discretion to take a “blue pencil” to put a line through words which make the restrictions too broad. This gave comfort to many as there was always the hope that a judge would edit a non-compete into enforceability. However, the Court of Appeal affirmed a narrower test — i.e. the court can only remove offending words if, in reality, they amount to a distinct restriction. For example, multiple restrictions might be bundled into a single clause. Therefore, here, the court could not delete “or interested in” and the non-compete was void.
Here are some key tips for drafting post-termination restrictions:
Take great care with “off the shelf” contracts – there is no such thing as a “standard” non-compete and post termination restrictions should be tailored to the reality of your business. Don’t be greedy when deciding on the length of restrictions. The courts have no power to reduce the length of the restriction and so the length shorter rather than longer.
Include a clause clearly permitting the removal of words in overly broad restrictions. This gives a sympathetic judge as much scope as possible to exercise their discretion to sever offending sections. Many businesses are choosing to split restrictions into multiple sub-clauses following the Tilman decision. While this may decrease risk of unenforceability, it can result in a bulky contract that looks intimidating (and may result in conflict during negotiations) so you should consider your options carefully.
Ensure that non-competes include saving provisions that allow for the holding of shares and similar passive investments. Execute fresh restrictions every time an employee is promoted or, ideally, annually. The reasonableness of a restriction is judged at the point it is entered into, therefore the more senior a person is the more likely restrictions are to be reasonable. Apply different restrictions for each grade of staff or area of the business. A one size fits all approach rarely works. Consider obtaining “pursuit” insurance cover to help pay for the legal costs of enforcing restrictions.
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