A restrictive covenant refresher (and the relevance for values-driven employers)

In July, employment lawyers across the country got a little bit excited, as for the first time in 100 years (since 1920!) our highest court (the Supreme Court) considered a case about restrictive covenants in employment contracts.

We felt this was particularly blog-worthy, partly for that reason, but also because it’s a useful reminder about the key principles of restrictive covenants.

We know that including such restrictions in employment contracts is something which purpose and values-driven employers sometimes shy away from, but should they?

What’s the legal development?

Last month, the Supreme Court overturned the previous Court of Appeal decision that a restrictive covenant in which a senior employee agreed not to ‘directly or indirectly engage or be concerned or interested in’ any competing business for six months after the termination of her employment was unenforceable.

A key focus of this case was the meaning of the words ‘interested in’ and whether this included having any shareholding in another company.  The Supreme Court agreed with earlier decisions that the words ‘interested in’ were unreasonably wide, as they prevented even a minor shareholding in a competing business, making it too restrictive. Importantly though the Supreme Court held that the words ‘or interested in’ could be cut (‘severed’) from the remaining parts of the restriction so that the wording overall became reasonable and enforceable.  What was left was that the former employee could not ‘directly or indirectly engage or be concerned’ with any competing business for 6 months.

The Court’s decision has effectively relaxed the approach to severing offending wording from covenants like this. The position is now broadly as follows:  specific words which make the restriction unreasonable can be deleted if 1) that can be done without needing to add extra words and 2) the removal of the unenforceable wording would not mean any major change in the overall effect of the covenants.

This means that there is now a greater chance of employers being able to enforce restrictive covenants against former employees.

What does this mean for values-driven employers?

We’ve experienced many values-driven employers being uncomfortable with including restrictive covenants in their employment contracts, perhaps feeling that such restrictions do not sit comfortably with an ethical approach to business.

We’d challenge that, at least discouraging an assumption that all covenants are ‘unethical’. The starting point in law is always that a restrictive covenant will only be enforceable if 1) it protects a legitimate business interest and 2) is no wider than reasonably necessary to protect that interest.  If your organisation is genuinely purpose and values-driven – an organisation which exists to provide a benefit to people or the planet, including those who work there – then surely it’s legitimate to take certain steps to protect that organisation and to help to secure its sustainability for the future? And why would employees object?

Unreasonably onerous restrictive covenants that may be contrary to ethical business practices, would be unenforceable in any event.

This recent decision helps employers and employees focus on the overall meaning of the covenant and whether it is reasonable, rather than covenants failing because the drafting hasn’t been technically tight enough. It will also have an impact on negotiations with former employees to try to insist they comply with the obligations they agreed to.

Some specific practical pointers from this case for employers:

– review whether any existing covenants might prevent a departing employee from holding even a small shareholding in a competitor (e.g. up to 5%) and ensure such shareholdings are excluded from the restriction;

– remember that the reasonableness of the covenants is assessed in the context of when the clause is issued to the employee – not in the context of the employee’s last role before they left. Make sure that they are kept updated if roles have changed;

– adequate consideration needs to be given for the covenant to be enforceable. This could be a one off payment, a pay rise or introduction of a new benefit, provided that it is genuinely linked to agreeing to the new covenant and would not have been paid anyway


Our comment

This case is a useful prompt for employers to take a fresh look at restrictive covenants and whether they are aligned to the purpose and values driven nature of their business. If employers are comfortable to include covenants in employment contracts, don’t be apologetic about this – just ensure the restrictions are reasonable to protect the organisation’s interests and be really clear with employees about why this is important