Post-termination restrictions (also referred to as restrictive covenants) are often found in employment contracts and seek to prevent employees from carrying out certain activities once their employment has ended. Examples of such activities include taking clients or employees from their former employer and working for competitors.
Such post-termination restrictions can be invaluable to employers in protecting the interests of their business. However, if the restrictions are not drafted correctly or are deemed to be excessive then they may not be legally binding and the courts may choose to not uphold them, as can be demonstrated in the recent decision in the High Court case of Law By Design Ltd V Ali.
The background to the case is that Saira Ali (the defendant) entered into a contract of employment at an employment law practice known as Law By Design Ltd (the claimant).
The defendant later entered into a Shareholders Agreement with the claimant in return for a 3% share of the claimant company. The Shareholders Agreement contained post-termination restrictions including a non-competition clause. The clause prohibited the claimant from competing with any business of the claimant company as operated at any time in the previous 12 months in a territory in which the company had operated such a business.
Following promotion to a director, the defendant also entered into a Service Agreement with the claimant. The Service Agreement contained an additional non-competition clause. The clause prohibited the defendant from competing with parts of the claimant company that she had been involved in to a ‘material extent’ in the 12 months before termination.
The defendant later resigned from her position at the claimant company and intended to work for a legal firm which was argued to be in competition with the claimant. Her business plan for the competing firm also involved the defendant taking clients that she had worked for at the claimant company during her employment to the competing legal firm.
Although both post-termination restriction clauses prohibited competition and protected legitimate business interests, the High Court applied the test in TFS Derivatives Ltd v Morgan. It concluded that only the restrictive covenant contained in the Service Agreement was found to be no wider than reasonably necessary to protect the legitimate business interests of the claimant company and an injunction was therefore granted to enforce the covenant. This is because it applied solely to parts of the claimant company in which the defendant was involved in to a ‘material extent’ 12 months prior to her leaving, rather than applying to all business of the claimant company irrespective of the level of her involvement.
In addition, the Shareholders Agreement clause failed the proportionality test because it effectively meant that the defendant could not work in England and Wales in relation to any competing business of the claimant company, as operated in the 12 months before the claimant ceased to be a shareholder. Consequently, the covenant was found to be wider than reasonably necessary to protect the firm’s legitimate business interests as it applied to all parts of the company’s business irrespective of the defendant’s degree of involvement and was, therefore, unenforceable.
The High Court decision in Law by Design Ltd V Ali should act as a warning to employers who are considering incorporating post-termination restrictions into employment contracts and shareholders agreements. Failure to correctly draft post-termination restrictions can be harmful to the interests of the business and so it is advisable to seek legal advice when drafting such clauses and keep them under review particularly where an employee is promoted or given a different role in the business.
If you require any advice on the drafting of employment contracts or enforcing post-termination restrictions, please contact Farleys’ experienced employment team on 0845 287 0939, email us or contact us through our online chat below.