Covenant governance

Windsor Recruitment is an example of how not to introduce restrictive covenants. By David Harper

Restrictive covenants are terms in a contract of employment that restrict the employee’s activities following termination of their employment. As is well known, conditions that restrict the freedom of the employee to work are prima facie void for illegality.

However, that general rule does not apply if the employer can show that there is a legitimate interest to protect and that the covenant imposed is no more than is reasonable to protect that legitimate interest.

Restrictive covenants range from an outright restriction on joining competitors or competitors within a specific geographical area, restrictions on dealing with or soliciting former clients and customers, and restrictions on recruiting former colleagues, all of which must be for a finite duration. When it comes to the interpretation of the reasonableness of the restriction, it is important to remember that it is the position of the parties when the contract is made that counts.

The best time to impose a restrictive covenant on a key employee is when they are recruited. However, there are a variety of reasons why an employer may decide that it is appropriate to impose restrictions on existing employees who do not currently have them, or to amend or redefine the restrictions that are in existing contracts of employment. The reasons may include a change in the employee’s circumstances, for example a promotion. Alternatively, it may be because the business has grown but has found itself under threat from rivals.

It was changes to the nature of the business and threats to poach staff made by a competing business set up by two former employees that led the employer in Willow Oak Developments Ltd (trading as Windsor Recruitment) v Silverwood & ors (2006) to embark on an exercise of imposing restrictive covenants on existing employees. This case is a shining example of how not to carry out HR practices and policies.

Windsor Recruitment employed consultants who placed staff in healthcare posts, mainly in the NHS. In May 2004, faced with attempts by a competing business to poach staff, Windsor Recruitment decided to ask all staff to sign various restrictive covenants and stated that anyone who refused to do so would be dismissed.

Without prior consultation, one of the company’s operations directors visited the Leeds office and handed copies of the covenants to each employee. He told each employee that they had 30 minutes in which to consider whether to sign. The employees persuaded the director to give them a little more time, but five days later he refused a request to extend the time further and told one employee that if the documents were not signed by the following day, they would lose their commission.

On 28 May all staff were called in to see the director and he produced a letter that purported to explain the proposed covenants. When he met Ms Silverwood, one of the claimants, he told her that the consultants were “silly girls playing unions”.

By 4 June only seven of the 26 consultants had returned signed covenants and those that had not were called in to see the director and dismissed. None of them had been given a formal warning that the sanction for non-compliance was dismissal. Ms Silverwood was told that the dismissal was happening because she was “ignorant enough” not to have read the contract properly.

Afterwards, Windsor Recruitment made a token gesture to retrieve the position, offering more time for deliberation. Ms Silverwood and her colleagues were adamant that the relationship had already broken down irretrievably and they commenced proceedings for unfair dismissal.

Although apparently not referred to at any stage in the litigation, the case is similar to that of RS Components v Irwin (1974), a case before the National Industrial Relations Court (NIRC) (the predecessor of the Employment Appeal Tribunal (EAT)). RS Components now seems to be a case well ahead of its time. The employer decided that it needed to introduce restrictive covenants. By contrast with Windsor Recruitment, it knew that it had to give advance notice of the proposed new contract and consult about it properly. At the end of the consultation period, a total of 88 out of 92 sales people agreed to sign the new contract.

Coincidentally, in the light of what happened in Windsor Recruitment, the employment tribunal in the first hearing in RS Components made a hash of the ‘some other substantial reason’ defence, deciding that this defence had to be interpreted eiusdem generis with the reasons specified in the equivalent of Section 98(1)(a) of the Employment Rights Act and that there was therefore no valid reason for dismissal.

Overturning this, the NIRC held that there was nothing in the section to preclude the tribunal from finding that the dismissal on the grounds of the need to impose the new restriction fell within the ‘some other substantial reason’ category. Employees who refused to sign the new contract could therefore be dismissed. The NIRC noted that the employer would have to devise covenants that were not void.

If the employment tribunal in Windsor Recruitment had been referred to RS Components, it might not have become so confused when it considered the reason for dismissal. It concluded that because of the unreasonableness of the proposed restrictive covenants, the employees’ refusal to agree to them could not amount to ‘some other substantial reason’ within Section 98(1)(b).

In Windsor Recruitment, having found that the employer had not satisfied the initial hurdle of showing an acceptable reason for dismissal, the employment tribunal concluded that it was not necessary to consider questions of fairness. However, it indicated that had it done so, it would have found the dismissals to be unfair because of the procedure adopted. The EAT quickly corrected the flaw in the reasoning on the grounds of dismissal, emphasising that the question posed by Section 98(1)(b) is whether the employer’s reason is of a kind such as to justify the dismissal. As decided in RS Components, an employer can conclude that new restrictive covenants are required. The EAT agreed with the findings of unfairness on procedural grounds. In the Court of Appeal, the employer’s appeals were dismissed.

It is ironic that a case decided in 1973 should demonstrate best practice, rather than a case decided in 2006. Employment law still has the capacity to spring a surprise.

David Harper is a partner at Lovells