Restrictive covenants: Stifling UK innovation and entrepreneurship? Restrictive covenants: Stifling UK innovation and entrepreneurship?

Restrictive covenants: Stifling UK innovation and entrepreneurship?
30 Jun 2016

The UK government has announced plans to look at whether post-termination restrictive covenants could be stifling British entrepreneurship by preventing employees from starting up their own businesses after leaving a job. So this could affect you if you have such a clause in your own contract.

The Department for Business, Innovation and Skills (BIS) has called for evidence seeking views on non-compete clauses in employment contracts. The concern is that these noncompete clauses may be acting as a barrier to innovation and employment.

Also there have been suggestions that they hinder startups from hiring the best and the brightest talent, and so prevent British start-ups from prospering. The press release suggests that entrepreneurial individuals need to be able to ease out of employment and into self-employment.

This call for evidence is part of the government’s project to develop an ‘Innovation Plan’ for publication later in 2016. The intention is it will set out how to help to make the UK a better place to turn ideas into new technologies and projects and will look at how better regulation can drive innovation.

Typical restrictive covenants

The government’s plans appear to focus on non-compete clauses. These prohibit a departing employee from joining a competitor, or setting up in competition for a set period after leaving.

Other typical restrictions include: • Non-solicitation of customers and or clients;

• Non-dealing with customer and or clients;

• Non-poaching of employees.

The restricted period will depend on business cycles and what the business is seeking to protect but six to twelve months is common. As these clauses are more onerous and therefore more difficult to enforce they are generally of shorter duration than other restrictions.

Are these restrictions enforceable?

It is often suggested that restrictive covenants are not enforceable – in which case why is the government looking at the issue at all? The general position in England and Wales is that a provision which restricts what an employee may do, after termination of employment, will be void. However, the exception is when the restriction goes no further than is reasonable to protect the employer’s legitimate business interest.

What this means ‘on the ground’ is that it is often possible to include valid and enforceable restrictions in a contract of employment but they need to be drafted very carefully. The clauses need to be tailored to the particular individual employment relationship, and updated and renewed as the employee progresses within the business. The less onerous the restriction is for the employee, the better the prospects of enforceability will usually be.

What if the employer pays the employee for the restricted period?

Around the world, different legal systems take very different approaches to restrictive covenants in employment contracts. In France, for example, employers need to pay employees for the period of time for which the restriction lasts.

There was considerable discussion about whether doing the same in the UK would make a restriction more enforceable. Earlier this year, the High Court confirmed that it does not.

In the case of Bartholomew’s Agri Food Limited v Thornton, the restriction stated that the employee’s full benefits would be paid if the employer relied on the restriction. The Court confirmed that this did not improve enforceability. Permitting an employer to buy a restraint of trade was contrary to public policy.

What if these restrictions are outlawed?

If restrictions in contracts of employment are outlawed, we can expect to see some entrepreneurial innovation from employers and their advisers.

Alternatives to the typical restrictive covenants (albeit these may, or may not, also be caught by any new prohibition on restrictions that is enacted) could include:

• Greater use of, and reliance upon, garden leave to protect the business from a departing employee. When an employee is required to spend the notice period on garden leave, the individual remains an employee. As an employee, the individual continues to owe to the employer a much higher level of obligation, including the obligations of honesty, loyalty, good faith and confidentiality. These may have to be strengthened, as some employees will start to build relationships with new employers. Garden leave periods that are excessively long will, however, also be void for reasons of public policy.

• Deferred remuneration schemes which make payments conditional upon certain behaviour, including not competing;

• Including restrictive covenants in a document other than the employment contract, for example a shareholders’ agreement;

• More tightly drafted intellectual property clauses in contracts of employment; • More tightly drafted clauses to protect confidential information in contracts of employment.

We will need to wait and see what happens next following the call for evidence. What entrepreneurs and startups will need to bear in mind is that the removal of employment restrictions would be a double-edged sword. It would help with hiring, but also make it much easier for those hired to turn, leave and compete afresh.

By Anne-Marie Balfour, partner, Parker Bullen LLPP

The UK government has announced plans to look at whether post-termination restrictive covenants could be stifling British entrepreneurship by preventing employees from starting up their own businesses after leaving a job. So this could affect you if you have such a clause in your own contract.

The Department for Business, Innovation and Skills (BIS) has called for evidence seeking views on non-compete clauses in employment contracts. The concern is that these noncompete clauses may be acting as a barrier to innovation and employment.

Also there have been suggestions that they hinder startups from hiring the best and the brightest talent, and so prevent British start-ups from prospering. The press release suggests that entrepreneurial individuals need to be able to ease out of employment and into self-employment.

This call for evidence is part of the government’s project to develop an ‘Innovation Plan’ for publication later in 2016. The intention is it will set out how to help to make the UK a better place to turn ideas into new technologies and projects and will look at how better regulation can drive innovation.

Typical restrictive covenants

The government’s plans appear to focus on non-compete clauses. These prohibit a departing employee from joining a competitor, or setting up in competition for a set period after leaving.

Other typical restrictions include: • Non-solicitation of customers and or clients;

• Non-dealing with customer and or clients;

• Non-poaching of employees.

The restricted period will depend on business cycles and what the business is seeking to protect but six to twelve months is common. As these clauses are more onerous and therefore more difficult to enforce they are generally of shorter duration than other restrictions.

Are these restrictions enforceable?

It is often suggested that restrictive covenants are not enforceable – in which case why is the government looking at the issue at all? The general position in England and Wales is that a provision which restricts what an employee may do, after termination of employment, will be void. However, the exception is when the restriction goes no further than is reasonable to protect the employer’s legitimate business interest.

What this means ‘on the ground’ is that it is often possible to include valid and enforceable restrictions in a contract of employment but they need to be drafted very carefully. The clauses need to be tailored to the particular individual employment relationship, and updated and renewed as the employee progresses within the business. The less onerous the restriction is for the employee, the better the prospects of enforceability will usually be.

What if the employer pays the employee for the restricted period?

Around the world, different legal systems take very different approaches to restrictive covenants in employment contracts. In France, for example, employers need to pay employees for the period of time for which the restriction lasts.

There was considerable discussion about whether doing the same in the UK would make a restriction more enforceable. Earlier this year, the High Court confirmed that it does not.

In the case of Bartholomew’s Agri Food Limited v Thornton, the restriction stated that the employee’s full benefits would be paid if the employer relied on the restriction. The Court confirmed that this did not improve enforceability. Permitting an employer to buy a restraint of trade was contrary to public policy.

What if these restrictions are outlawed?

If restrictions in contracts of employment are outlawed, we can expect to see some entrepreneurial innovation from employers and their advisers.

Alternatives to the typical restrictive covenants (albeit these may, or may not, also be caught by any new prohibition on restrictions that is enacted) could include:

• Greater use of, and reliance upon, garden leave to protect the business from a departing employee. When an employee is required to spend the notice period on garden leave, the individual remains an employee. As an employee, the individual continues to owe to the employer a much higher level of obligation, including the obligations of honesty, loyalty, good faith and confidentiality. These may have to be strengthened, as some employees will start to build relationships with new employers. Garden leave periods that are excessively long will, however, also be void for reasons of public policy.

• Deferred remuneration schemes which make payments conditional upon certain behaviour, including not competing;

• Including restrictive covenants in a document other than the employment contract, for example a shareholders’ agreement;

• More tightly drafted intellectual property clauses in contracts of employment; • More tightly drafted clauses to protect confidential information in contracts of employment.

We will need to wait and see what happens next following the call for evidence. What entrepreneurs and startups will need to bear in mind is that the removal of employment restrictions would be a double-edged sword. It would help with hiring, but also make it much easier for those hired to turn, leave and compete afresh.

By Anne-Marie Balfour, partner, Parker Bullen LLPP