It takes businesses years and even decades to build up their customer base and cultivate their employees. When an employee resigns or has his/her employment contract terminated by an employer, there is always a risk that he/she might join a competitor and poach clients and employees of the employer. It is of utmost importance that such risk is minimized as far as possible in accordance with the law.
In this article, we will discuss how to utilize post-termination restrictive covenants in employment contracts to protect an employer against the risks identified above.
1. What are Restrictive Covenants?
A restrictive covenant is a contractual clause which aims to regulate the activities of the employee after the termination of their employment relationship. Some examples of post-termination restrictive covenants are as follows:-
Non-compete covenants
- These covenants restrict the departing employee from working in a similar job position for a competitor of the employer.
Non-solicitation of employees
- These covenants prevent the departing employee from recruiting their former colleagues to join them in their new employment.
Non-solicitation of clients
- These covenants prevent the former employee from dealing with the clients of the employer.
2. When are restrictive covenants enforceable?
Restrictive covenants are generally considered as restraints on trade and unenforceable unless the employer can justify that it is reasonable in all the circumstances to protect a legitimate business interest.
2.1 What are “legitimate business interests”?
The burden falls on the employer to demonstrate that the restrictive covenant is used to protect a legitimate business interest. Examples of legitimate business interests are the protection of relationships with customers and suppliers, business goodwill, confidential information or trade secrets and a stable workforce. Employers invest a lot of time and money to develop and maintain these assets and it would be unfair to allow departing employees to exploit them. However, these assets of the employer must be distinguished from the employee’s personal skills and knowledge acquired from the employment.
It should be noted that the prevention of competition is not considered a legitimate interest. The Court will not allow employers to rely on restrictive covenants to reduce competition in the market on grounds of public policy.
2.2 What makes the clause reasonable?
Even if the employer can show that there is a legitimate business interest to protect, it does not mean that the Court will automatically allow any and all restrictions. In order for the restrictive covenant to be enforceable, it must be no wider than what is reasonably necessary to protect the employer’s legitimate interest. What is “reasonably necessary” depends on the facts of the case. The Courts will look at the following factors to determine the question of reasonableness:-
(i) the scope of activities restricted;
(ii) the duration of the restrictions; and
(iii) the geographic scope of the restrictions.
Generally, the broader or wider the restrictive covenant is, the harder it will be for the employer to justify that it is reasonable.
(i) Scope of Activities
The types of activity that the employer seeks to restrain must be one which the employee was engaged in during the previous employment. For instance, a hairdresser should not be restrained from working as a nail technician, or a teacher should not be restricted from being a textbook salesperson. In determining the scope of activities to restrict, the employer should consider the nature of its own business and the level of competition in the market. They should also consider the departing employee’s level of seniority and access to confidential information. For instance, a distinction should be made between junior and senior-level employees, since it is more likely that senior-level employees will have access to valuable information.
(ii) Duration of the Restraint
In determining a reasonable period, the employer should consider the shelf-life of the business interest that they are aiming to protect. For instance, if the employer is imposing the restrictive covenant to protect customer relationships, then a reasonable duration would be the time it will take for a new employee to re-establish a relationship with the customer to prevent the departing employee from luring customers away. Alternatively, if the employer is trying to protect confidential information, a reasonable time period would be however long such information might be valuable or capable of doing harm if exposed to the employer.
(iii) Geographic Scope of the Restraint
The geographic scope of the restraint is often considered against the duration of its applicability, such that a longer duration might be justified by a narrow geographic scope, or vice versa. When determining the geographic scope, the employer should consider how widespread their business activities are and presence of competition. While it might be simple to restrict a hairdresser from engaging in the same employment within a 2-mile radius of the employer’s place of business, it will not be simple to identify a reasonable geographic scope where the employer’s activities and competitor’s presence takes place from any location. Worldwide restrictions are not automatically unenforceable, but typically harder to justify.
It must be emphasized that there is no precise formula to draft an enforceable restraint as each case depends on its own set of facts. The Court’s goal is to strike a balance between the competing interest of the employer protecting their business interests and the employee’s freedom to seek alternative employment.
2.3 Severance of Restrictive Covenants – “Blue Pencil Test”
If the Court finds a restrictive covenant unreasonable, it will not assist an employer to rewrite it into a reasonable one. However, the Court will allow the severance of the unreasonable parts of the clause. This essentially allows the employer to cross out parts of the clause, without adding or modifying the remaining words. If the remaining words can be construed as a reasonable restraint, then the Court may uphold the covenant.
What action can an employer take if a former employee breaches a restrictive covenant?
The primary remedy available to the employer is to claim damages which would try to put the employer back in the position that he would have been in if the contract been properly performed. However, in some cases, employers should seek for an urgent Court injunction to restrain any conduct of the employees which may be in breach of the restrictive covenant as soon as they become aware of the breach or potential breach. Employers have to demonstrate to the Court that the restrictive covenant they rely on is enforceable based on the factors discussed above, and that damages would not be sufficient to compensate their loss.
Conclusion
Not all employment relationships need the protection of a restrictive covenant. Employers should carefully consider the nature of the employment relationship when determining whether or not to include a restrictive covenant in the employment contract. If there are serious concerns about the post-termination activities of the employee, then it would be sensible for the employer to utilize restrictive covenants.
For more information on the above topic, or general employment issues, please contact the author below:
Author:
Ronald To
Partner, E-mail：ronaldto@wktoco.com, +852 3628 0117
