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Employee Confidentiality / Restrictive Covenants / Business Interests

Restrictive Covenants and Confidentiality

Many employers will strive to protect themselves against the harmful competitive activities of employees and ex-employees and prevent the disclosure of trade secrets and confidential information by such individuals.  The law allows such protection by the use of confidentiality clauses and restrictive covenants.  The extent of the protection that the law offers to employers depends largely on whether the employee is still employed by the employer.  This fact sheet looks at the ways in which employers can try to protect themselves against the competitive practices of employees and ex-employees.

Categories of confidential information

There are three broad categories of information available to employees, which help in defining the limits of an employee’s duty of confidentiality during and after employment.  They can be broadly summarised as follows:

Trivial information (class 1): information which is easily accessible from public sources and which an employee is free to use and disclose.  This is not protectable.

Confidential information (class 2): this covers information that must be kept confidential by an employee during employment.  Once learned, such information remains in the employee’s head and becomes part of their skills or knowledge base but as long as employment continues, it cannot be used for anything other than the employer’s business interests.  However, once employment ceases, the employee is entitled to use such skills or knowledge for their own benefit or for that of a future employer.

Trade secrets (class 3):  this refers to information that is so highly confidential that, regardless of whether or not the employee is still in employment, it cannot be used for the benefit of any person other than the employer.  This information is protected indefinitely, as long as it objectively retains the quality of confidential information.

Confidentiality during employment

During employment, an employee is under a number of implied obligations to their employer, including an implied duty of confidentiality and implied duties of trust and confidence and good faith.  The former means that the employee is under an obligation not to disclose to unauthorised third parties their employer’s confidential information and trade secrets obtained during the course of employment.

However, in cases where employees have access to confidential information, it is always advisable to insert an express confidentiality/non-disclosure clause into the employee’s contract of employment which makes it clear that they must not reveal such information during employment.  Such a clause can usefully define the information that the employer classes as confidential.  Employers are able to discipline employees for disclosing confidential information during employment and the case will be strengthened where there is an express clause that has been breached.  Note that class 3 information does not require an express confidentiality clause and class 1 information cannot be protected by an express clause.  Class 2 information can, however, be protected by an express confidentiality clause during employment.

Information will not be confidential where it is already within the public domain.  Employers must also consider whether the disclosure by the employee was justified as being in the public interest, for example where the disclosure falls within the remit of the Public Interest Disclosure Act 1998.

Employees should be free to seek new employment if they wish. As part of that, an employee might learn confidential information about the business or dealings of a potential employer who might also be a competitor. In those circumstances, there is no obligation on the employee to inform his existing employer of what he has learnt. In fact, it could be a potential breach of a duty of confidentiality which the employee owes to the potential employer. However, the particular circumstances of each case may have a bearing as to which company the employee owes an obligation. It will be a question of fact as to whether the employee should keep this new information to himself, or whether he has a fiduciary obligation under his contract to report the information to his existing employer.

Confidentiality after employment

When an employee leaves employment, they are generally free to use the skills, training and knowledge gained during their employment.  However, employers are entitled to protect their information which can properly be classed as a trade secret or information which, while not properly described as a trade secret is, in all the circumstances, of such a highly confidential nature as to require the same protection as a trade secret (class 3 information).  Unfortunately, there is no generally accepted definition of what information amounts to a trade secret.  Essentially, it is likely to constitute information which, if disclosed to a competitor, would be liable to cause significant damage to the employer’s business.  Each case will turn on its own facts but it may include: secret manufacturing processes, chemical formulae, designs or special methods of construction, customer lists and confidential price lists.  In determining whether information is a trade secret, the court will have regard to the nature of the employment, the nature of the information, whether the employer impressed on the employee the confidentiality of the information and whether the relevant information can easily be isolated from other information which the ex-employee was free to use or disclose. 

Employers who wish to protect themselves should ensure that employees are subject to an express post-termination confidentiality/non-disclosure clause preventing disclosure of trade secrets and highly confidential information when employment ends.  It is always better to have an express clause than to rely on an implied duty.

Enforcing confidentiality clauses

It is normally easier to enforce a restrictive covenant than to enforce an express or implied obligation of confidentiality, post-termination of employment.  Restrictive covenants give certainty whereas the line between information which is confidential and information which is not is hard to draw.  However, if there are no express post-termination restrictive covenants, they cannot be implied and the employer will then have to rely on express/implied obligations of confidentiality.

The courts may enforce confidentiality clauses by the use of injunctions and search orders/orders for 'delivery up'.

Springboard injunction: an injunction may be obtained as a means of protecting the employer against the competitive activities of ex-employees who have wrongfully used confidential information, for example, a customer list obtained during employment.  It is used to prevent the ex-employee from taking an unfair advantage of the springboard they have gained by the misuse of the confidential information.  Essentially, the ex-employee is not allowed to use the confidential information as a springboard for activities detrimental to the owner of that information.  If an injunction is granted, it should not normally extend beyond the period for which the unfair advantage may reasonably be expected to continue.  The requirements for a springboard injunction are:

  • There must be an initial breach of confidence.
  • The confidential information has been disclosed but not with the authority of the employer.
  • The employee has obtained an unfair advantage or head start by the use of the confidential information.
  • The employee is continuing to derive an advantage from the head start.
  • The injunction can restrain the employee both from entering into future contracts and from fulfilling existing contracts with third parties.

Search order/delivery-up order: a search order is used in cases where the employer believes that confidential documents or documents containing trade secrets have been taken and the employee will destroy those documents if they become aware of legal proceedings. Although it is rare, this could involve inspection of an employee's personal computer. An order for delivery-up orders delivery up of documents or other property belonging to the employer.

Account of profits: the employer could alternatively try to seek an account of profits for breach of confidence i.e. all profits the employee has made due to the breach.   There is no requirement for the employer to mitigate its losses.

Damages for breach of contract: an employer is entitled to sue an employee who has acted in breach of contract for any direct and actual losses incurred as a result of the breach of confidentiality complained of.

Restrictive covenants

One of the most effective means of protecting a business from competition is to ensure that employees are bound by enforceable post-termination restrictive covenants.

Restrictive covenants in the context of employment contracts are covenants placing restrictions on an employee’s activities once employment has ended.  They need to be express: they cannot be implied.  The starting point is that restrictive covenants are void as a matter of public policy because they are in restraint of trade.  Such clauses will only be upheld against the employee to the extent that they are reasonably required for the protection of the employer’s legitimate business interests. 

A restrictive covenant will not be enforced if its sole purpose is to prevent the employee from competing with their ex-employer or from using the skills, experience and knowledge acquired during their employment.  For the covenant to be enforceable, it is essential that three conditions are fulfilled:

  1. It protects a legitimate business interest – an employer has a legitimate interest in (a) its trade secrets and confidential information, (b) its trade/customer connections or goodwill, and (c) protecting the stability of its workforce.  There is no requirement to identify the legitimate interest in the covenant itself but where the covenant does identify the legitimate interest, the employer is stuck with having to rely on that interest and cannot rely on a different one.
  2. It is drafted no wider in scope than is reasonably necessary for the protection of that business interest. 
  3. It is not otherwise contrary to the public interest.

Even if the covenant is held to be reasonable, the court will then still decide whether, as a matter of discretion, an injunction should be granted.  For example, they will look at the amount of time left to run on the covenant, any delay in enforcement (and the reasons for it), the likely utility of an injunction and whether the employer could be adequately compensated by readily calculated damages or an account of profits. An injunction will not usually be required where the employees provide an undertaking to comply with the restriction. However, even if an undertaken is given, if it is breached or withdrawn, the court will still consider the above factors in determining whether to impose an injunction. Where an injunction will serve no useful or real purpose it will not be granted.

Incorporating new restrictive covenants

Employers should make sure that the restrictive covenant actually forms part of the employee’s contract of employment and that the employee is made aware of it before they accept the job.   When providing new contracts to employees during their employment we would always advise that a signed copy of the contract is received back from the employee. There have been certain limited circumstances when a Court has found an unsigned contract was enforceable but this is not guaranteed (and may costs a significant amount of legal fees to determine).  There is also case law which has concluded that even where an employee has signed a new contract of employment containing restrictions these may not be enforceable unless the employer can show that the employee has received some real benefit (consideration), specifically in relation to these changes. Such benefits may include a pay rise, improved pension, or healthcare provisions. Therefore, in order to assist in terms of enforceability employees should be asked to sign new contracts and the benefits they are receiving in return made clear to them. 

Where an individual does not agree to accept a new contract containing restrictions, it may be possible for an employer to insist on an employee accepting a restrictive covenant when it comes under a competitive threat and then to fairly dismiss the employee on SOSR (some other substantial reason) grounds if they refuse.  It will depend on whether the employer acted reasonably or unreasonably in treating that reason as sufficient to dismiss the employee.

Changing Roles within an organisation

The courts have ruled that one of the tests applied to the enforceability of a covenant is whether it was enforceable at the time it was applied to the employee. Whenever an employee changes roles or jobs within an organisation, whether a promotion or side ways move, an employer should consider whether new restrictive covenants should be drafted for the role. It may not be safe to assert in an offer letter that "your terms and conditions of employment otherwise remain unchanged" and an employer could find itself without protection.

Types of restrictive covenant

There are four main types of restrictive covenant.  These are covenants against:

  1. Working for a competitor, or carrying on a competing business on the employee’s own behalf (non-compete covenants).
  2. The soliciting of the employer’s clients or customers (non-solicitation covenants).
  3. Dealing with the employer’s clients or customers (non-dealing covenants).
  4. The soliciting of the employer’s other employees (non-enticement covenants).

Restrictive covenants need to be very carefully drafted on a bespoke basis, preferably by a solicitor.  It is not possible to adopt a ‘standard form’ approach to their drafting because they need to be tailored to suit the role of the particular employee and the nature of the employer’s business (each profession, trade or industry will have different levels of acceptability).  The clause must impose the minimum level of restriction necessary to do the job.  Employers should therefore consider which type of restrictive covenant is necessary to protect their legitimate business interest – using the least onerous type of covenant possible.  Employers also need to carefully consider the wider picture when seeking to restrict a particular employee/role as the Courts will look at covenants in colleagues' contracts (particularly more senior colleagues) and the length of the employee's notice period when deciding whether to uphold and enforce a restriction.

Modes of restriction

Restrictive covenants may place restrictions on:

  1. Area: covenants of this kind restrict an employee from competing in a geographical area where the employer has legitimate business interests.  The court will normally expect a localised client base commensurate with the radius given in the covenant.  The area is normally larger in rural areas and smaller in urban areas.
  2. Scope: restrictive covenants of this nature must be carefully defined with regard to the business interests of the employer which they seek to protect.  So, for example, an employer will not be allowed to enforce a restrictive covenant attempting to prevent a business activity which is wider than the activities the employer’s business would normally be involved in.
  3. Time: restrictive covenants must be reasonable in relation to the length of time for which they restrict competition.  A clause not limited in time is likely to be unenforceable.

Drafting and enforcing restrictive covenants

The draftsman has two goals: (a) to give the covenants the best possible chance of being held to be enforceable, and (b) to limit the competitive activities of the ex-employee to the maximum extent consistent with their being enforceable.  Once drafted, they should be regularly reviewed to ensure they are still up-to-date.

Non-compete covenants: covenants which restrain employees from working for a rival company, or working for the former employer’s clients or customers, or setting up a rival business in competition, after they have left the employer’s employment are known as non- compete covenants.  These are the most difficult to enforce as they are the most restrictive/draconian.  The only way such covenants may be acceptable is in a case where the covenant limits the ability of the ex-employee to carry out certain prohibited activities in a specified geographical area for a limited duration of time (usually no more than six months).  Sometimes, it may be better to refer to specific named competitors rather than a geographical area.  In cases where the employer’s legitimate business interest can be adequately protected by another lesser form of covenant (such as a non-solicitation covenant), the court will not uphold a non-compete covenant.  As far as prohibited business activities are concerned, employers should define these as closely as possible.  For example, if an employee goes to work for a competitor but in an entirely different role which presents no risk to the employer’s legitimate business interests, they should not be restrained.  It is common to limit the area of business to the specific business activities in which the employee was personally involved when working for the employer. The key factors here are therefore: duration, geographic area and prohibited business activity.

Non-solicitation covenants: this type of covenant prevents an employee from soliciting, canvassing or accepting any work from the former employer’s existing customers or clients for a period of time (usually six months).  Such a covenant will be enforceable if it is necessary to prevent the employee from using their personal influence over their former employer’s customers or clients, and the knowledge of their requirements, which they acquired during the course of their employment, to entice them away from their former employer.  The covenant should preferably only include those customers or clients with whom the employee actually had personal dealings (or specific knowledge of) in a defined time period prior to the termination of their employment (usually no more than 12 months).  The key factors here are therefore: duration, definition of the client/customer/supplier and prohibited business activity.

Non-dealing covenants: covenants of this nature prohibit employees from having any dealings with their former employer’s customers or clients for a period of time (usually no more than six months).  It prevents ex-employees from responding to customers and clients who approach them unsolicited, as well as restraining ex-employees from dealing with the customers and clients who they approach.  Again, the covenant should only include those customers or clients with whom the employee actually had personal dealings (or specific knowledge of) in a defined time period

prior to the termination of their employment (usually no more than 12 months).  The key factors here are again: duration, definition of the client/customer/supplier and prohibited business activity.  A non-dealing covenant is more onerous than a non-solicitation covenant (as it prohibits dealings even if the client approached the ex-employee) and hence is harder to justify – but easier to enforce because a breach is normally easier to prove on the facts.

Non-enticement covenants: this type of covenant prevents the ex-employee from enticing away their former employer’s other employees for a period of time (usually six months).  However, it should not cover all employees.  Such a covenant should specifically refer to the seniority or knowledge and experience of particular employees and ensure that employees who join after termination of the employee’s employment are not covered.  The key factors here are therefore: duration, definition of the staff and prohibited business activity.

Severance of clauses

Where there is a covenant which prescribes a number of separate restrictions, the court may take the view that it is reasonable to have one kind of covenant but unreasonable to have another.  The common law permits the court to uphold some of the restrictions imposed while holding invalid other restrictions, provided that each restriction is independent and can make sense and stand in its own right i.e. without the necessity of adding to or modifying the wording of what remains.

However, the court cannot rewrite an unenforceable or badly drafted covenant in order to make it effective and enforceable, for example by substituting a shorter time limit than the one set out in the clause.  Normally, the whole covenant will fail unless the court can take what is unreasonable out of the covenant by applying the ‘blue pencil’ test i.e. by deleting the offending words of the covenant while leaving the meaning intact. 

General rules of construction

  • The wording of the covenant must be clear and certain.
  • Words used are given their ordinary meaning.
  • The covenant must be interpreted in the context of the agreement as a whole and to give effect to the intention of the parties.
  • Generally, the court has no power to re-write the covenant – if unreasonable, it is void and unenforceable.
  • However, the court can sever – or ‘blue pencil’ – an unenforceable provision, leaving a valid and enforceable provision.

Breach of contract and restrictive covenants

If an employer dismisses an employee wrongfully (in breach of contract), or otherwise commits a repudiatory breach of contract, normally he will be prevented from enforcing any restrictive covenants in the ex-employee’s contract of employment.  To partly deal with this, employers should consider inserting a clause entitling them to terminate the contract by making a payment in lieu of notice where the contract also contains restrictive covenants.  However, be aware that a PILON (pay in lieu of notice) clause in the contract will generally make this payment taxable as earnings, whereas without such a clause it is sometimes possible to make such a payment without deduction of tax.

If an employee is dismissed for gross misconduct but the misconduct did not amount to gross misconduct, this will not only be an unfair dismissal but also a wrongful dismissal, again enabling the employee to get out of the restrictive covenants.  Employers therefore need to be particularly careful when dismissing employees for their competitive activities during employment to ensure that the actions complained of do in fact amount to gross misconduct.

The same principle would apply where the employee resigns alleging constructive dismissal on the basis of fundamental breach of contract/breach of the employer’s duty of trust and confidence: some employees may purport to do this to avoid having to be bound by their post-termination restrictive covenants.

Restrictive covenants and Garden leave

An employer may restrict or deny an employee who has resigned and is working out their notice period access to confidential information and/or customers, suppliers and clients by placing the employee on ‘garden leave’.  A garden leave clause has the effect of requiring an employee to serve their period of notice at home.  During the period of garden leave, the employee would be entitled to their full salary and benefits, while at the same time they must not work for anyone else and they continue to owe obligations of good faith and confidentiality.  The aim of the employer in imposing garden leave is to maintain the employee’s fidelity whilst at the same time ensuring the employee does not maintain his contacts with the employer’s customers, suppliers, clients and confidential information.

For garden leave to be enforced there must be an express clause included in the employee’s contract of employment.  Otherwise, putting an employee on garden leave could amount to a repudiatory breach of the right to work, and may invalidate any restrictive covenants.

When drafting restrictive covenants and specifically the period of the restriction post-termination of employment, employers should consider whether a garden leave clause would suffice instead. 

Although there is no rule of law saying that a restrictive covenant cannot run on after a period of garden leave or that the period covered by a restrictive covenant must be ‘set-off’ against a period of garden leave, it will be very difficult for an employer to convince a court that a long restrictive covenant following a substantial period of garden leave is a reasonable restraint.  It is therefore often sensible to insert a provision off-setting one against the other (i.e. the period of prohibition is reduced by the period for which the employee is actually placed on garden leave).

Enforcement and remedies

Injunction: an interlocutory or interim prohibitory injunction may be used as a temporary order restraining the employee from acting in contravention of their contract of employment, pending the full trial of the action.  In this case, the employer would have to provide evidence to support the allegation that the employee is or is about to act in breach of their post-termination covenants.  It is only in exceptional circumstances that an ex parte injunction (i.e. without notice to the other side) will be granted.  Normally, an injunction is sought on notice to the other side.  There is generally no need for the employer to prove damage/loss (except in exceptional cases).  The court will decide whether, as a matter of discretion, an injunction should be granted.  For example, they will look at the amount of time left to run on the covenant, any delay in enforcement (and the reasons for it), the likely utility of an injunction and whether the employer could be adequately compensated by readily calculated damages or an account of profits.

Damages: the employer is entitled to sue an employee who has acted in breach of contract for any direct losses incurred as a result of the breach complained of.   The financial loss to the employer’s business must be quantifiable.  Since it is often difficult to prove that a victim of unlawful competition has suffered financial loss, damages calculated on the traditional compensatory basis may be nominal. 

Account of profits: the employer could alternatively try to seek an account of profits for breach of confidentiality or fiduciary duty i.e. all profits the employee has made due to the breach.  There is no requirement to mitigate.

Claims against the new employer: an employer whose ex-employee has disclosed or is threatening to disclose confidential information to a competitor, or who has entered or is threatening to enter the employment of that competitor in breach of a restrictive covenant, may be able to bring a claim against the competitor himself, even though the competitor was not a party to the original contract.  This is the economic tort of inducing breach of contract.  There are three elements to it:

  • Knowledge that a breach will be induced – a conscious, deliberate decision not to enquire into the question whether a breach will occur is treated as equivalent to knowledge. There is also evidence to suggest that an employer who is reckless about or "takes a chance" on whether an employee will be in breach, that employer may be liable for inducing any subsequent breach.
  • Intention to induce a breach.
  • Actual breach of contract.

There is also an economic tort of unlawful interference with the employer’s business/inflicting harm by unlawful means (where the new employer intended to cause the old employer loss by its unlawful act).  The economic tort claims will result in a claim for damages.  It is sensible to join the new employer if compensation is important (the new employer will have more funding means than the ex-employee) but if restraint rather than compensation is the objective, it is unhelpful.

Taking legal action can be very expensive and time-consuming so employers should think very seriously about bringing such claims. Before considering litigation, where there is reason to believe an employee is in breach of restrictive covenants, the employer should start by sending a letter threatening legal action against both the ex-employee and the new employer and requesting an undertaking from the ex-employee within seven days that he will not breach, or will immediately cease any action which is in breach of, the terms of the restrictive covenants

Jurisdiction

Proceedings in relation to the enforcement or breach of restrictive covenants must in almost all cases be brought in the County or High Court and not in the Employment Tribunal.  This is because most disputes in relation to the enforcement or breach of such covenants fall outside the jurisdiction of the Employment Tribunal.  The tribunal has no power to issue injunctions.

 

 

This document has been created by, or on behalf of ESP Ltd, as a general document and as a guide in relation to its subject matter and has not been bespoke drafted for you or the specific circumstances in which you are looking to use it. Prior to using this document and undertaking any HR process you must consult your organisation’s own policies and procedures to ensure that you do not do anything in conflict with your own policies and procedures.  If in any doubt as to how to use this document or, if you require any legal advice, please feel free to contact ESP Ltd on 0333 006 2929 and our legal team will be more than happy to assist.  ESP Ltd will not be liable in any way for any actions undertaken by you or your use of this document unless we have been consulted regarding your use of this document as legal advisor to your business or have bespoke drafted any documentation in response to a specific support request.