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Law at Work — February 2014: reasonableness and extent of restrictive covenants did not apply to actions as a minority shareholder
28 February 2014
Are people expendable? Are they a cost or an asset? If you subscribe to the 'people are assets' viewpoint, how safe are those assets? Are your or your clients' businesses vulnerable to them walking out of the door to make money for a competitor?
Part of the employer's armoury in these circumstances (alongside providing stimulating work, an effective reward scheme and developing a positive culture) has always been the use of restrictive covenants.
Views range from "they're not worth the paper they're written on", via "we might as well have them if only as a deterrent", to "I want to enforce them to the letter", all of which are familiar points on the continuum to practitioners in this area. But where does the reality lie?
Given that covenants in restraint of trade are potentially void on public policy grounds, this is an area in which case law provides an essential guide to practitioners.
The non-compete covenant
For many years the non-compete covenant has been perceived as the hardest to enforce. This is particularly the case in the UK (unlike in many foreign jurisdictions) where it is rare for the employer to pay the employee during the restricted period.
The ability to demonstrate the existence of the need to protect genuine confidential information of the nature of a trade secret is paramount. Each case turns on its own facts, so the value of the Court of Appeal's judgment in Huw John Phillip Thomas v Farr and Hanover Park Commercial (2007) is that common types of such information are identified.
As managing director, Thomas possessed pricing and financial information (including details of the budget overviews and business plans) and business development knowledge (including acquisition strategy and the examination of new markets).
Such information was protectable by the non-compete covenant for 12 months; a non-solicitation covenant would not suffice, particularly because it was difficult to police. The court was not persuaded by the argument that Thomas could not recall the confidential information he possessed, although such a factor, if proven, could affect the ability to obtain an injunction.
In Beckett Investment Management Group v Hall (2007) the departing employees, described as "not run of the mill, expendable employees", left and set up a competing business together.
Like many professional advisers, they took the view that if loyal clients chose to follow them because of their personal relationship, they would consider themselves free to act for them. The court disagreed and in doing so overcame a number of potential barriers to enforceability:
- A key definition (that of prohibited services) failed to refer to subsidiaries of the holding company employer. The judge found that failure to be fatal to enforceability. However, the Court of Appeal overruled this, with the leading judge stating: "I do not feel inhibited by a purist approach to corporate personality." Thus the holding company could protect its subsidiaries' interests.
- The non-deal covenant existed alongside a non-solicitation covenant. Even clients who wanted to move were therefore effectively prevented. Nonetheless the court accepted the covenant was reasonable.
- The covenant was for 12 months. The judge considered the period "purely arbitrary" and suggested three months. Again the Court of Appeal overruled, stating that while a period in excess of 12 months would not have been reasonable, 12 months was. This was based on the seniority and importance of the individuals, the time that it would take to replace them and stabilise the client base, evidence of business patterns and uncontradicted evidence of standard industry practice.
Protecting your database
In PennWell Publishing (UK) v Ornstein and Others (2007), 18 of PennWell's files containing contact details for power industry members and conference delegates were copied onto a CD by a departing employee. At PennWell, Mr Isles stored a mixture of personal and work contacts in the email account address book. As the database contained his own "journalistic contacts", he believed he was entitled to a copy after he left to set up competition.
Despite a concerted effort to demonstrate to the court "the highly personal nature of the files", the Court found that a wholesale import of the database was unlawful and granted PennWell a permanent injunction preventing use of it.
The judge found that an address list in the email system (such as Outlook contacts) and backed up by the employer is exclusively the employer's and the employee is not entitled to exclusive or shared use. This was true even when the list was derived from a list brought by the employee from his previous employment and updated, despite the fact it contained a proportion of purely personal contacts.
Given this case law, there are several considerations that employers should take into account:
- It is vital to define confidential information carefully if you intend to rely on a non-compete covenant. Do not be tempted to use a 'standard' confidentiality clause.
- Knowledge of confidential information increases with seniority. Therefore update contracts when promoting people.
- Think carefully where the real competitive danger is and draft exemptions that allow the individual to work. Do not be greedy and try to stop the individual from working at all. Carefully consider the time period for restrictions. As the judge at first instance said in Beckett, there is "no magic in the period of one year". Key factors will be how much time will be needed to persuade clients to stay loyal, evidence of business patterns and industry standard practice.
- Consider who needs to be protected and have regard to associated and linked businesses as well as subsidiaries.
- Ensure that email policies are clear about the ownership of information held on work systems and the policy is demonstrably communicated to all employees.
Employees wishing to store a list of personal contacts for use at work should create a separate list and seek permission to treat the list as their own property.
Employers should not routinely clear information left on a departing employee's computer. In PennWell, Mr Justin Fenwick QC said: "The list would, as a matter of fact, have been entirely lost to the claimant had Mr Isles not taken a copy with him on his departure."
If information is taken, be creative about the orders you seek and consider an imaging order to preserve evidence of misuse of confidential information. For example, in TML Financial Solutions v More Business and ors (2007) the court ordered the defendants who had stolen and stored confidential information on a memory stick to allow TML to image any of the defendant's computers on which the stick had been stored, despite arguments that it would affect third parties and disrupt the defendant's business.
Merrill April is a partner at Memery Crystal