Are restrictive covenants a shot in the arm or the foot?
8 August 2005
As first revealed by The Lawyer (1 August), Bournemouth-based Lester Aldridge is trying to enforce a covenant that would force its head of banking Kevin Heath to repay 30 per cent of all fees earned from former Lester Aldridge clients in the year after he leaves.
Although this is one of the most extreme examples, even the most reasonable restrictive covenants can prove difficult to enforce.
Restrictive covenants in partnership contracts typically govern client relationships. They employ client solicitation and dealing clauses requiring a defecting partner to refrain from courting or working for his previous firm's clients.
There are obvious problems with this type of restriction. In today's climate, where much of the client work is built upon personal relationships, a client may decide of its own volition to follow the partner to their new firm.
David Pester, managing partner at regional firm TLT Solicitors, believes that in the end clients will have the casting vote. "We haven't had any personal experience of this, but I would think it would turn on what the agreement is between the two parties. But ultimately what the client decides matters the most," he says.
For many City lawyers the influence of big clients such as banks can make clauses such as this redundant. John Woodhall, managing partner at Sidley Austin Brown & Wood London, certainly thinks this is the case. "These days, a client of one firm is also likely to be working with the other major City firms. There's very little exclusivity. Therefore, if a client demands that they want a particular partner working on a deal, even after they've left the firm, the old firm will have very little choice but to agree," he says.
Notice periods provide another potential battleground. Six, nine or 12 month notice periods are not uncommon in the UK. For example, the Norton Rose capital markets team that recently quit to join Baker & McKenzie is currently working out its one-year notice period.
US firms, though, take a very different approach to that of their UK counterparts. Most have no restrictive client covenants at all, and many allow lawyers to move almost immediately.
Whatever the dispute, it is still rare for firms to take their fight to the courts. Firms and their partners prefer to avoid washing their dirty linen in public if possible. But when disputes do reach court they are often bloody. The most high-profile recent case was between the Hong Kong offices of Deacons and White & Case over two insolvency lawyers.
In 2002, Deacons filed a suit alleging that White & Case had breached a non-recruitment clause in an agreement dating back to 1999 when the two firms were in merger talks. At first White & Case looked to have won when an arbitrator ruled that Deacons could not hold the partners to a five-year restrictive covenant. However, in October 2003 a court in Hong Kong ruled in favour of Deacons, with the judge accusing White & Case of "a cynical disregard for the rights of Deacons". The case finally drew to a close the following year in October 2004 when the two sides reached a settlement.
As a footnote, and a warning for other predatory firms, one of the partners at the centre of the row has now quit White & Case to join Tanner de Witt less than six months after the Deacons case was settled.
Mark Brandon, a consultant with legal recruiters First Counsel, believes firms are shooting themselves in the foot by taking such extreme measures. "A firm will have a greater benefit in the long run if a partner leaves on good terms, as they stand to get referral business," he explains.
And firms may find that the partnership deed does not offer as much protection as first thought. "It's harder to enforce a partnership deed than an employment contract," says Herbert Smith litigation partner Alan Watts, "and when he leaves, a partner can usually negotiate the terms."
The Lester Aldridge affair remains an extreme example of how things can get sticky very quickly.