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Work Matters: Post-termination restrictive covenants - non-compete clauses.

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AnalysisLaw by Design Ltd v AliBackground Post-termination restrictive covenants are clauses which restrict an ex-employee’s ability to compete with the employer for a certain per...

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Date: 05/05/2022

Authors:

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Mike Tremeer

Partner
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Caroline Philipps

Senior Associate

Analysis

Law by Design Ltd v Ali


Background

Post-termination restrictive covenants are clauses which restrict an ex-employee’s ability to compete with the employer for a certain period after their employment has ended. These clauses will be void (for being an unlawful restraint of trade) and unenforceable, unless the employer can demonstrate that it has a legitimate business interest to protect and that the clauses go no further than is necessary to protect that interest.

Such covenants are often contained in employment contracts, director service agreements, settlement agreements or commercial contracts (such as shareholders’ agreements). Generally covenants in shareholders agreements are more likely to be considered reasonable and enforceable than those in employment contracts because they are negotiated in a commercial context and there is a relative equality in bargaining power between the shareholders.

Employees can be subject to different kinds of restrictive covenants, depending on what business interest an employer is aiming to protect. To stop employees joining a rival or setting up in competition a ‘non-compete’ clause is needed. However, any blanket attempt to deny an ex-employee the right to make a living in their chosen industry or profession is taken very seriously by courts and is unlikely to be enforceable. Non-compete clauses are more difficult to enforce than less restrictive provisions, such as those which restrict the ex-employee from dealing with particular customers or from poaching employees.

If, after the end of their employment, an ex-employee refuses to comply with the restrictive covenants set out in their employment contract, the employer can seek an injunction from the court to enforce compliance. However, it will be for the employer to prove that the restriction is reasonable and therefore enforceable.

Facts

Ms Ali, was employed by Law By Design Ltd, a boutique law firm specialising in employment law work for mainly NHS employers in the North West of England.

In 2016, Ms Ali entered into a shareholders’ agreement that included a non-compete restrictive covenant. The clause provided that she could not be engaged, concerned or interested in, or assist, any business which competes, directly or indirectly, with the business of the company in an area in which it had operated in the previous 12 months.

In 2018, Ms Ali was promoted to the role of director and in January 2021 she signed a new service agreement which contained a 12 month non-compete clause. This provision prohibited Ms Ali, for 12 months after the end of her employment, from being involved in a ‘restricted business’ (which was defined as any company in competition with Law By Design in the areas Ms Ali had been involved to a material extent in the 12 months prior to the termination of her employment). The non-compete clause in her employment contract was narrower than the one in the shareholders’ agreement.

Ms Ali received a substantial pay rise in return for signing the service agreement.

In May 2021 Ms Ali resigned (giving the required six months’ notice) in order to join a national law firm which also provided services to NHS clients in the North West of England. Around the same time, Ms Ali prepared a seven-page business plan in which she referred to ‘transitioning’ clients generating annual fee revenue of around £250,000 (over a third of its annual turnover) from Law By Design to her new employer.

Law By Design asked Ms Ali to agree (or undertake) that she would comply with the non-compete restrictive covenants in both her shareholders’ and service agreements. However, Ms Ali refused and said they were too wide and lasted too long to be enforceable. Law By Design applied for an interim injunction to enforce both the covenants.

High Court decision

The High Court granted an injunction to enforce the non-compete clause in Ms Ali’s service agreement but not the clause in the shareholders’ agreement (despite these usually being easier to enforce).

The High Court accepted that the restriction in the service agreement was enforceable because:

  • Law By Design had a legitimate business interest to protect, which was the customer connections built up by its employees with NHS bodies in the North West of England.
  • The clause was drafted no wider than was reasonably necessary to protect that business interest. Critically, the restriction was limited to the parts of Law By Design’s business that Ms Ali had recently been involved with to a material extent.
  • Although the 12-month duration was at the limit of what might be enforced, it was reasonable in these circumstances. Law By Design would need this length of time after Ms Ali’s departure to re-establish its legal and commercial relationships with its NHS clients in that geographical area, including finding another lawyer to replace her.

Ms Ali’s case was not assisted by her business plan (to remove more than 30% of Law By Design’s client base and fee income). The Court considered that Ms Ali wanted to be free to do the very kind of work the non-compete clause was designed to prevent and the clause was a necessary solution to protect Law By Design’s interests. The non-compete clause in the service agreement would operate to prevent Ms Ali competing with Law By Design for NHS client work in the North West until November 2022.

The non-compete covenant in the shareholders’ agreement was held to be void (and not enforceable) because it was wider than was reasonably necessary for Law By Design to protect its legitimate business interests. It prohibited any competition (directly or indirectly) with Law By Design across England and Wales and it was not limited (in contrast to the service agreement) to competing with that part of the business in which Ms Ali had recently worked. Further, the Court confirmed that if the restriction in the shareholders’ agreement had been in the service agreement, it would not have granted the injunction.

Fladgate comment

Overall this is a positive decision for employers and highlights how a carefully crafted 12 month non-compete restrictive covenant in a service agreement can be reasonable and, importantly, enforced.

The employer was successful in this case because the non-compete clause was tightly drafted with close reference to the specific business interests to be protected and Ms Ali’s particular ability to damage those interests. As a result, the employer could establish that the restriction went no wider than was necessary. However, it also helped that the employee was a senior employment lawyer who knew exactly what she was agreeing to when she signed up to the 12 month non-compete clause in return for a big pay rise, only a few months before she resigned.

That said, the non-compete clause in the shareholders’ agreement was held to be unenforceable despite the employee’s seniority, experience and relative equality in bargaining power. In the end, it was the drafting that was crucial to the decision. The fact that it was drafted too widely and went beyond what was reasonably necessary to protect the employer’s legitimate business interests rendered it unenforceable.

Employers should note that given the potential for non-compete restrictions to inhibit employees from taking new job opportunities (or starting new businesses) the Government has consulted over proposals to limit their enforceability - or even to ban them entirely. We are waiting the Government’s response to this consultation with no timeframe for this available at present.

In the meantime, take care when drafting non-compete clauses because small details can have a big impact, including rendering them unenforceable. If you would like our help advising on post termination protections or on any of the issues in this bulletin, please do contact us.

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