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Restrictive covenants in employment contacts and shareholders’ agreements

30 March 2022

The threat of competition for business from other organisations often leads employers to include what are usually known as ‘restrictive covenants’ (or ‘post-termination restrictions’) in their employees’ contracts of employment. For the same reason, companies and partnerships usually include the same sort of restraints in their shareholder and partnership agreements.

Both groups of covenants must be reasonable, both in scope and in duration, going no further than reasonably necessary to protect legitimate interests, in order to be enforceable. Where an employee is also a shareholder, they will often therefore be subject to two sets of covenants.

Recent example case

In a recent High Court case (Law By Design Ltd -v- Ali [2022] EWHC 426 (QB)), the defendant employee was subject to similar restrictions in both types of agreement, but only the covenant in one of the agreements was held to be enforceable.

The defendant, Ms Ali, had joined the claimant law firm in 2013 and had become a shareholder in 2016. She became a statutory director of the limited company in 2018. Both the service agreement that Ms Ali signed governing her employment, and the shareholders’ agreement, contained covenants that sought to prevent her from joining a competitor (a ‘general non-compete’ covenant) for a period of 12 months after leaving. In the service agreement, Ms Ali was also prevented (or ‘restrained’) from soliciting clients for a certain period, or for using confidential information. Such covenants are common, and are usually easier to enforce than general non-compete covenants, because the latter is a more severe restriction on the employee’s ability to work and therefore less likely to be deemed a reasonable means of protecting legitimate interests.

The claimant brought a claim for an injunction against the departing employee, who was joining a larger competitor law firm, and obtained an injunction, but only succeeded in relation to the covenant contained in the service agreement (i.e. the agreement governing the defendant’s employment). The initial considerations for the court, in deciding whether each covenant was enforceable, were the same. But ultimately, the difference in wording (and therefore ambit) led to a different conclusion in respect of each covenant.

The court’s decision

One of the crucial factors in the court’s consideration in this case was Ms Ali’s seniority. In the judgment, the history of employment with Law By Design Ltd is summarised, and it shows how she was gradually promoted and given more responsibility, which led to her establishing very strong and significant client relationships (in this case, with NHS Trusts) and being privy to very business-critical confidential information. That is not an unusual scenario, and not one that means a general non-compete covenant will be automatically enforceable. However, certain factors were deemed important by the court that favoured upholding the covenant in the service agreement:

  • The court found that the non-solicitation and confidentiality covenants were not adequate to protect the firm because in these circumstances (a senior person, with a shareholding, in an open-plan office of a small firm) it would be extremely difficult to determine if either had been breached
  • The general non-compete covenant did not prevent Ms Ali working anywhere or in any role; it was restricted to the region and areas of business in which she had been involved
  • There was evidence Ms Ali intended to “transition” business to her new employer
  • The nature of the business “readily created the circumstances in which close and enduring relationships were built up…”
  • In terms of the restricted period of 12 months, this was realistic, given the shelf-life of confidential information and recruitment and integration of someone of her seniority and knowledge would take considerable time

The corresponding covenant in the shareholders’ agreement, by contrast, was considered by the court to be too wide in scope. It did not contain the same geographical and business-area limitations as the covenant in the service agreement. However, the court did comment that “the imposition of a non-competition covenant” would have been justifiable – but not this one.

Conclusions

In conclusion, often unenforceable general non-compete covenants may be enforceable, provided they are limited to what is reasonably necessary to protect the organisation’s legitimate interests, and provided other types of covenant (e.g. non-solicitation, non-dealing and confidentiality) can be shown to be inadequate on their own, as a means of protecting such interests.

This article is provided by Burlingtons for general information only. It is not intended to be and cannot be relied upon as legal advice or otherwise. If you would like to discuss any of the matters covered in this article, please contact Richard Berry or write to us using the contact form below.

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