Chris Tutton explores the use of restrictive covenants in limiting an employee’s activities after their term of employment has ended
A series of mergers and acquisitions have affected the property sector in recent months: Savills acquired Smiths Gore in April, swiftly followed by the merger of Cushman & Wakefield with DTZ in May. Such activity brings with it both challenges and opportunities for the industry. Companies may be more willing to invest and expand, but change is inevitably followed by a period of uncertainty, which can encourage key staff to look for new opportunities.
In the course of employment, senior employees inevitably develop client relationships and acquire confidential information and knowledge of key business interests. In a booming property market, it is tempting for employees to use these contacts and information after their employment has ended to further their own interests or those of a new employer.
In an industry that is very much contact-driven, property companies’ success often depends heavily on the strong personal relationships between senior employees and clients. When key individuals choose to leave, businesses can often find themselves exposed. Business leaders must therefore take appropriate measures to protect their commercial interests by ensuring that their contracts of employment contain the appropriate protections for the nature and seniority of an employee’s role.
Do restrictive covenants work?
The short answer is “yes”, but there are invariably pitfalls. Covenants can restrict employees’ activities for a period after their employment has ended by, for example, stopping them from competing for work, poaching clients and/or staff, or using and disclosing confidential information. But covenants will only be enforceable if they protect a “legitimate business interest” – a high hurdle for employers to clear.
Restrictive covenants should be tailored to the particular circumstances so they are proportionate and reasonable. A blanket ban on competing with your business for 12 months after termination is unlikely to be reasonable. Employers should consider: the length and geographical area of the restriction; the impact of the covenant on the employee; the seniority of the employee; and ensure that the restriction goes no further than is necessary in the circumstances.
Keeping contracts up-to-date
Case law in this area is constantly evolving. A recent Court of Appeal decision (Prophet plc v Huggett [2014] EWCA Civ 1013) confirmed that covenant clauses will be strictly interpreted by the courts. Employers will not be given the benefit of the doubt if there is any ambiguity in the drafting, and this may be fatal to their case.
In our recent survey of 250 companies, 45% of businesses had not audited their contracts in the past year. By failing to regularly review the contracts of senior employees, businesses put themselves at risk. Roles and responsibilities change over time and if contracts do not reflect these changes, they may not give sufficient protection. It is therefore important to review the contracts of senior employees frequently. Companies should ensure that the terms reflect any changes to the employee’s role and, to protect commercial interests, particular attention should be paid to key clauses, especially notice periods and restrictive covenants.
The right notice period
Employers are sometimes reluctant to give lengthy six-to-12 month notice periods due to the expense involved in buying employees out of them and the potential harm that can be caused by having a reluctant employee working through this period.
However, providing companies include “gardening leave” provisions in their contracts of employment, lengthy notice periods are a very effective tool for tying in key employees and helping companies respond appropriately to departures. Gardening leave clauses allow employers to send an employee home or give them alternative duties during their notice period, thus restricting an employee’s activities. It is also far easier to enforce a period of gardening leave in the courts, than to enforce a restrictive covenant.
Businesses need to ensure that notice periods give them enough time to replace senior members of staff, and need to consider the likely time it would take to recruit this replacement. This may take as long as 12 months, particularly if the new hire is tied into a lengthy notice period.
According to recent research undertaken by Irwin Mitchell, 88% of companies believe that their notice periods are sufficient and they have given themselves enough time to replace senior employees. However, the availability of good candidates fluctuates over time and depends on external economic factors. Companies should be mindful of the risks of too short a notice period and consider the protection gained by extending it.
Policing the covenant
While 75% of companies surveyed said that they have restrictive covenants in place, only 3% say that they had been held back from recruiting senior employees for fear that they may be accused by a competitor of inducing the individual to breach their contract. This disparity suggests that post-termination obligations have previously been poorly drafted, or have not been effectively policed by employers (or a combination of the two).
However, a potential indicator of the growing importance of restrictive covenants is the appetite among businesses for litigation. When asked whether they were more likely to litigate breaches of restrictive covenants now compared to 12 months ago, more than a quarter of businesses said they would. Businesses are clearly keen to protect against the loss of clients and confidential information and this finding points to an increased willingness among senior decision-makers to resort to litigation (or the threat of it) as the economy improves.
Property companies must therefore not become complacent. Around one in 10 businesses reported being affected by the loss of clients or sensitive information following the departure of a senior staff member. This should start alarm bells ringing. In a fast-moving property industry with increased levels of movement in senior ranks, it could just be a matter of time before reliance on contractual protections is needed.
Chris Tutton is head of the London employment law team at Irwin Mitchell
