MJ O'Connor Solicitors

The Brief

01.10.2007

Restrictive Covenants in Employment Contracts

How effective are restrictive convents in employment contracts? This is a complex question with, unfortunately, no straight forward answer.

All business people will appreciate the need for restrictive covenants in their employment contracts. Many employers find it hard to find and retain good employees. They invest considerable time and money in training and, inevitably, the employees acquire a great deal of knowledge about the employer’s business. Employers will want to ensure that their contracts with their employers prevent the employee using that expertise and knowledge to the detriment of the employer’s business.

By using a restrictive covenant the employer seeks to prevent the ex employee from setting up a competing business, soliciting clients or employees or otherwise “profiting” from his expertise learnt from the employer.

But how effective are these conditions?

A number of areas of law need to be considered.

Competition Law

Do these conditions offend competition law? Should each contract of employment with a restrictive covenant be referred to the Competition Authority? Thankfully, no!

The Competition Authority has always accepted that an employee is not an Undertaking (an important term in competition law) and therefore a contract of employment was not an agreement between Undertakings for the purposes of Competition Law. The 1992 Competition Notice stated that Employment Agreements were not subject to the provisions of the Competition Act.

There was some doubt, however, when an employee left and set up in business…is he then an undertaking and is the restriction subject to competition law criteria? In January 2007 the Competition Authority clarified the position and by withdrawing its 1992 notice and the consensus now is that even if the employee sets up business on his or her own behalf the contract restriction does not have to be referred under the Competition Act.

Therefore when employers are formulating Non-Competition clauses in their contracts they now need not concern themselves with the Competition Act but need to look purely at Common Law.


Common Law - Restraint of Trade.

The other area of relevant law is the Common Law Doctrine of Restraint of Trade.

The Common Law (i.e. the body of law and principles built up through court decisions) does protect trade secrets and confidential information. However, employers are well advised to put specific conditions in their contracts to restrain existing employees and particularly ex-employees rather than relying on Common Law. The Courts will only uphold such clauses, however, if they satisfy strict criteria.

In general the law acknowledges that competition is good and that restraint of trade is bad. There is an acceptance that an employee should have the right to earn or ply his or her trade. However, the law does recognise that in some cases restraint of trade is necessary to protect goodwill. A restraint of trade clause or non-compete condition will be upheld by the Courts in certain circumstances:-

• Where there is legitimate interest to be upheld and
• Where the restriction is reasonable between the parties.

An employer who runs a restaurant may well be reasonable in restricting his head chef from working as head chef in the same town for say 6 months. Would he be reasonable restricting table waiting staff in a similar way?

What is reasonable and what will be effective depends on the circumstances of each case.

Restrictive Covenant clauses need to be drafted extremely carefully. Legal advice should be sought so that the interest to be protected is defined carefully and the clause is drafted appropriately. A widely drafted clause is dangerous because it can be struck down as an unreasonable restraint of trade.

The Court is adopting a balancing role, balancing the right of the employer to protect his business as against the right of the employee to earn his/her livelihood. The first rule of thumb is that the employer, therefore, has to establish that he/she has a legitimate interest to be protected. The restriction must also be reasonable in terms of subject matter, duration and geographical extent.

It is always useful to look at previous cases. In the 2005 case of Murgitroyd and Co –v- Purdy the Plaintiff company’s business was very specialised - the provision of intellectual property services with eight offices all over Europe. They hired the Defendant as a Patent Attorney to work out of the Dublin office. The Contract of Employment contained a clause restricting him from carrying on business in competition with the Plaintiff Company within the Republic of Ireland for a period of 12 months.

The Defendant left and immediately set up practising under his own name competing against his former employer apparently contrary to the clause in the Employment Contract. The Plaintiff Company sued. The Defendant argued that the Non-Competition clause was un-enforceable as an un reasonable restraint of trade. The judge in the case restated the general principle that a restraint of trade will not be upheld unless it meets a two fold test:
• It is reasonable between the parties
• It is consistent with the interests of the public.

While he upheld the geographical area and the twelve month term because of the specialised nature of the Company’s business, he took the view that a blanket restriction on all competition was too wide. His words are worth reading-

“Covenants against competition by former employees are never reasonable as such. They may be upheld only where the employee might obtain such personal knowledge of and influence over the customers of his employers as would enable him if competition were allowed to take advantage of his employer’s trade connections…. The prohibition in this case on all competition is too wide. A prohibition on dealing with (in addition to soliciting of) customers of the Plaintiff would, in my view, have been reasonable and sufficient to meet the legitimate requirements of the Plaintiff. The wider prohibition which restricts dealing with those who might be, but are not, such customers is excessive”.

This shows how important it is to focus on the actual interest to be protected and not to try to restrict beyond that. An employer cannot simply enforce a restrictive covenant in an Employment Contract which restricts a former employee from competing with it. Such a covenant will only be enforceable if it goes no further than is necessary to protect the legitimate interests of the employer.

Twelve months was considered reasonable in the circumstances of the Purdy case, however, in general the Courts will only uphold a clause which places a restriction no longer than is necessary to allow the employer take steps to minimise the damage done by the departure of the former employee. What is considered reasonable depends on the fact of each particular case, but it appears that a restriction on trade for longer than six months to a year is unlikely to be upheld.

It is common for Restrictive Covenants to seek to restrict ex-employees in relation to a wide description of conduct and activity related in some sense to the business of the employer. Another recent case, European Paint Importers –v- O’Callaghan suggests that the courts may be pulling back on enforcing such clauses in their totality.

In that case the Contract contained a condition as follows:-

“The employee covenants with the company that he will not for a period of one year after ceasing to be employed by the company, in connection with the carrying on of any business similar to or in competition with the business of heavy duty coating and industrial paint sales on its own behalf or on behalf of any person, firm or company directly or in-directly seek to procure orders from, or do business with, any person, firm or company who has at any time during the one year immediately proceeding such cessation of employment done business with the company”.

This condition is common enough in Employment Contracts. In the particular case the Defendants had solicited clients actively. However, Mr Justice Peart did make comments as to the validity of the clause. His views have to be considered as remarks only. He was of the view that it was unreasonable to have a situation where, even if no business was solicited by the ex employee but an existing customer of the employer freely and voluntarily wanted to do business with the ex employee the ex employee would be bound to refuse. He commented that this “would amount to an unwarranted restriction and serve only to unreasonably and unjustifiably place an obstacle in the way of a fledgling company which is legitimately entitled to get off the ground. It seems to me that the most which ought to be required of the Defendant is not to take any positive steps to seek business from existing customers of the plaintiff for a period to twelve months.”

From this we can see that it is unreasonable to prevent former customers of the former employer from going to the new business where that customer’s business has not actively been solicited by the former employee.

This is a compelling argument and it is likely that the argument would be followed in subsequent cases, even though in that particular case the decision went the other way based on the facts.

The Courts will also consider the geographical extent of a restriction clause. If the restriction is too wide and covers a greater area than is required to protect the employers business interest then it will be struck down.

Even if your clause is drafted carefully you have the difficulties of enforcing the condition…..a warning letter may be sufficient, you may have to consider expensive injunctive proceedings or claim for damages. You may be unsuccessful in obtaining an quick injunction as the courts may decide that damages would be an adequate remedy. As always the person seeking to enforce the condition has to prove his case. Proper evidence has to be proved to the court.

Conclusion
Employers are well advised to include Non-Competition clauses in their contracts to protect their business against key employees leaving. It is foolhardy to rely on the Common Law protection in respect of trade secrets and confidential information. Having said that, employers need to be very wary about how they draft their Non-Competition clauses in contracts. Such clauses need to be very distinctly and carefully drafted, identifying the interest to be protected, the particular threat from the leaving employee and setting out clearly the activities being restricted. The other factors which must be considered are the length of time of the restriction and the extent of the area over which the restriction operates.

The risk to the employer is that the Courts will strike down the clause as an unreasonable restraint of trade and the employer will fail in his or her attempt to prevent the former employee from setting up in competition.

Careful drafting and advice is essential.


For further information contact Catherine O’Connor of our employment department
coconnor@mjoc.ie

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