How do restrictive covenants work?

Restrictive covenants can apply to employees, workers, consultants, contractors, partners, office holders, shareholders and members of a limited liability partnership.

For the purposes of this webpage, the information provided is in the context of employee and employer but the principles remain the same.

Restrictive covenants are often included as clauses in an employment contract or in a separate agreement. The purpose is to prohibit an employee from doing certain things during their employment (eg sharing sensitive business information) or after their employment ends (eg by working with their employer’s customers) and are referred to as post-termination restrictive covenants.  Such post-termination restrictions will generally only be enforceable where the employer has provided valuable consideration for agreeing to them (eg the offer of employment or a pay rise).

Restrictive covenants are intended to protect an employer’s legitimate business interests and should extend no further than is reasonably necessary to protect those interests. If not, a restrictive covenant may be unenforceable.

If an employer believes that an employee has breached a restrictive covenant they have signed, it will generally need to take court action to show that:

• the terms of the covenant have been broken
• the covenant meets the necessary standard to be enforceable.

What is garden leave?

Many employment contracts will include a garden leave clause, specifying that an employee will not work for an employer during their notice period and will simply sit at home. Excessively long periods of garden leave may be unenforceable.

Normally, any period of garden leave, will reduce the length of any post-termination restrictive covenants by the time an employee is sat at home.

Are there different types of post-termination restrictive covenants?

There are various types of restrictive covenant that an employee may be asked to sign by an employer, which are:

• non-compete, which restricts an employee from taking similar employment with a competitor of their employer
• non-solicitation, which prevents an employee from contacting trade connections of their employer or former employer and attempting to secure work from those trade connections
• non-dealing, which prevents an employee from working with their employer’s trade connections, regardless of whether they have approached the trade connection
• non-poaching, which prevents an employee from attempting to ‘poach’ employees from their employer (eg if an employee intends to start their own rival business or wished to convince co-workers to join them at a new employer).

How do restrictive covenants affect your rights?

Employees generally have the right to terminate their employment with their employer and seek alternative employment elsewhere as they see fit. Anything that interferes with that right may be considered a restraint of trade and therefore not enforceable.

Restrictive covenants cannot generally interfere with an employee’s rights to:

• make a living in their chosen profession or industry
• place unreasonable restrictions on them
• go beyond protecting the employer’s legitimate business interests
• be unreasonable for their position within the business.

However, a restrictive covenant may trump an employee’s rights under certain circumstances, if the clause has been correctly drafted and consideration has been provided for agreeing to the restrictions.

What are enforceable restrictive covenants?

Whether or not a restrictive covenant will be enforceable depends on several factors.

The three main factors are that the terms of the restrictive covenant must:

• be designed to protect an employer’s legitimate business interests
• not place unreasonable restrictions on an employee
• not be excessively wide in scope.

Specific factors that may affect whether an employment restrictive covenant is enforceable include:

• the geographical area of the restriction
• the length of time of the restriction
• the activities that the employer is trying to restrict
• the type of interest being protected (eg trade secrets may be granted wider protection than customer information, given that its potential use across markets is wider)
• an employee’s position within the business.

If a restrictive covenant comes before a court for a decision on whether it is enforceable, the default position is that it will not be. It will be for the employer to argue that the covenant is enforceable and when deciding this, the courts will typically pay attention to what is standard practice in the industry.

Restrictive covenants may initially look too wide and unenforceable. However, courts can sever parts of the clause applying what is called the blue pencil test, provided that upon removal there would then be no need to add to or to modify what remains and the removal would not generate any major change in the overall effect of all the post-termination restrictive covenants in the contract (Tillman v Egon Zehnder Limited).

The material contained in this web page is provided for general purposes only and does not constitute legal or other professional advice. Appropriate legal advice should be sought for specific circumstances and before action is taken.