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Mishcon Academy: Digital Sessions podcast – Restrictive Covenants

Posted on 28 October 2021

The Mishcon Academy Digital Sessions.  Conversations on the legal topics affecting businesses and individuals today. 

Jennifer Millins
Welcome and thank you for joining us.  I am Jennifer Millins, a Partner in the Employment Team at Mishcon de Reya and I am joined remotely by my fellow Employment Partner, Susannah Kintish.  In this episode, we will be discussing what the most recent case law developments on post-termination restrictive covenants mean for employers.  We will also be discussing the Government’s proposals for changes to the law.  Hi Susannah.

Susannah Kintish
Hi Jennifer.

Jennifer Millins
So, the first case on our list is Quilter against Emma Falconer and Continuum.  I understand this case involves the ex-employer, Quilter, bringing a claim against their previous employee, Miss Falconer and her new employer, Continuum.  So, what’s interesting about this case?

Susannah Kintish
So, firstly I think it might be useful, in the hope that I am not teaching anyone to suck eggs, to remind everyone of the starting point in respect of post-termination restrictions.  So, post-termination restrictions will be void as an unlawful restraint of trade unless they can be justified as protecting a legitimate business interest.  Legitimate business interests can include protection of an employer’s trade connections with customers or suppliers, confidential information or maintaining the stability of its workforce.  Any restraint must also be reasonable and go no further than necessary in protecting the relevant legitimate interest.  Finally, the restraint must not be contrary to the public interest.

Now the Court assesses reasonableness at the time the covenant was entered into, hence the crucial importance for all post-termination restrictions to be tailored to the specific individual and the relevant fact pattern at the time, including the potential damage they could cause the business upon exit, as was highlighted in the Quilter case.  So, when Miss Falconer joined Quilter as a Financial Advisor, she was recruited to take over the clients of another advisor so, she was going to have access to clients and confidential information from day one.  Her contract contained confidentiality obligations, garden leave provisions, a nine month non-compete and a twelve month non-solicitation and non-dealing covenants.  Miss Falconer’s time at Quilter was short-lived and after less than six months in the role, she decided to resign.  She was still in her probationary period at the time so, only had to give two weeks’ notice.  She was placed on garden leave.  She then joined Continuum, a competitor, as a self-employed independent financial advisor.  Quilter brought a Breach of Contract claim against Miss Falconer and sought an interim injunction to enforce the restrictive covenants.  Quilter alleged that Miss Falconer had taken confidential information, breached her duty of fidelity and contacted clients during her garden leave period.  Quilter also sued Continuum for allegedly inducing Miss Falconer to breach her contract.  Now, the first point to note is that the Court dismissed the claim of inducement against Continuum.  Whilst Miss Falconer had taken Quilter’s confidential information and uploaded this to a portal provided by Continuum, Continuum were not aware of this and knowledge is a fundamental ingredient of an inducement claim.  Merely facilitating a breach without knowing about it, is not enough to amount to inducement.  Here, having failed to make out its claim against the new employer, Quilter had to foot the bill for Continuum’s legal fees, which were not cheap.  Miss Falconer was found to have breached her contract in a number of respects; she had scanned confidential client information onto her personal laptop; she hadn’t shown Continuum her contract of employment with Quilter, as required by her contract, so as to put Continuum on notice of her restrictions, she had attended an induction course with her new employer while still employed by Quilter and she had contacted Quilter’s clients during her garden leave with a view to soliciting business but despite all of this, the High Court decided that the restrictive covenants were void even though Quilter had legitimate interest to protect, the restrictive covenants went too far. 

Jennifer Millins
That’s really interesting so, even though a lot of wrongdoing was found by the Court, Quilter couldn’t actually enforce its post-termination restrictions.  Why did the Court say that they were not enforceable?

Susannah Kintish
Well, in relation to the nine month non-compete, the Court ruled that it was wider than reasonably necessary for the protection of its legitimate business interests and was therefore void.  The Court made a number of useful observations.  Firstly, the shorter the period of notice, the less important to the company the employee’s services would appear to be.  It follows that the perceived need for protection is diminished.  Secondly, the length of an employee’s notice period could be an indication of the unreasonableness of the length of the restraint.  Given Miss Falconer’s notice period was only two weeks during her probationary period, it was unreasonable on the facts of this case for her to be prevented from working for a competitor for nine months when she resigned during her probationary period.  Thirdly, Quilter’s legitimate business interest could have been sufficiently protected by other restraints, including a non-dealing covenant, whereas a non-compete prevented Miss Falconer from doing business with clients who had nothing to do with Quilter. 

The twelve month non-solicitation and non-dealing clauses were also unenforceable.  Both restricted Miss Falconer from soliciting or providing financial services to anyone who had been a client of Quilter in the eighteen months before her termination and with whom she was materially concerned or had material contact during that time.  However, the restrictions were not limited to clients she had dealt with or those who had been clients during the course of her employment.  So, the clause operated to prevent her from soliciting or dealing with her family or clients that she had not even met but were allocated to her, on the basis that she would be materially concerned with them.  The eighteen month backstop was also a problem as the information may well have lost its confidentiality after eighteen months.  As a result, the Judge decided that the restrictions went further than necessary to protect Quilter’s legitimate business interest and so were unenforceable. 

Jennifer Millins
Wow, I imagine that Quilter felt the judgement was quite a harsh one, given the clear wrongdoing perpetrated by Miss Falconer when she left.  It’s a reminder, however, that specific and clear drafting is key when considering post-termination restrictions.  A restriction on the face of it can seem pretty innocuous and standard when pulled apart in the way that you’ve just described.  If the restrictions overreach then they will fail regardless of how poorly the departing employee has behaved.  One of the key takeaways from this case is that employers should reconsider whether a short notice period during a probation period is appropriate in circumstances where individuals are expected to have client contact and access to confidential information from the outset.  The ability to dismiss someone quickly without paying for a longer notice period may be outweighed by having more enforceable post-termination restrictions that protect those legitimate business interests. 

Susannah Kintish
Absolutely, it’s also a useful reminder that employers must consider updating covenants as employees progress through the ranks, have access to more confidential information and deepen relationships with clients and employees.  One of Quilter’s more senior employees had a shorter non-compete of six months which didn’t help Quilter persuade the Judge that Miss Falconer’s nine month non-compete was reasonable.  Employers should therefore benchmark their restrictive covenants across the business.  In some cases, employers may want to include shorter and more limited covenants at the outset of employment or during their probationary period, if appropriate. 

Jennifer Millins
Yeah, I agree with that.  Thank you, Susannah.  So, the next case follows on quite nicely and it’s a really important Court of Appeal decision that clarifies what knowledge is required for the tort of inducing a breach of contract.  In this context, this means a claim against a new employer or a former employee for inducing a departing employee to breach their covenants.  There are a number of elements required to establish a claim for inducement to breach but critically, the new employer or former employee must know of the existence of the relevant term in the contract, for example, in our case a post-termination restriction, and they must know that the conduct they are inducing or encouraging would result in a breach of that term. 

Susannah Kintish
Yeah, I mean this is an interesting one.  As you say, the question will usually arise where you have an employer who is in the process of recruiting an employee or a team.  In that context, it is usual for new employers to seek legal advice on the enforceability of the covenants contained in those employee’s contracts.  This is what happened in Allen v Dodd & Co.  Mr Pollock was employed by Allen.  His contract contained non-solicitation and non-dealing covenants.  Mr Pollock resigned and secured employment with Dodd, who was a competitor.  Dodd sought legal advice prior to Pollock starting his new role on the issue as to whether the restrictive covenants were enforceable.  The advice was that it was more likely than not that the restrictive covenants were unenforceable.  Upon considering the legal advice, Dodd were of the view that the covenants were unenforceable and proceeded to engage Mr Pollock accordingly.  Allen then sued Mr Pollock for breach of the covenants and Dodd for inducing Mr Pollock to breach his contract.

At the hearing, the Court held that the covenants were in fact enforceable and that Mr Pollock was in breach.  However, the appeal centred around whether Dodd had sufficient knowledge to induce the breach of contract in circumstances where Dodd had received legal advice, which turned out to be incorrect, that it was more likely than not that the restrictions were unenforceable.  The first instance Judge did not think Dodd had sufficient knowledge to make it liable for the tort of inducing breach.  Dodd did not turn a blind eye to Mr Pollock’s contractual obligations, nor were they indifferent to them because they sought legal advice and they honestly relied on that advice. 

Jennifer Millins
Now that’s a tricky one.  So, it’s not necessary for the legal advice to be wrong for this sort of situation to occur but it is rare that lawyers can give unequivocal advice on the enforceability of a covenant.  For all the reasons we’ve discussed, assessing whether a covenant is enforceable requires careful consideration of the particular facts and circumstances in each case and many of those facts and circumstances won’t be known to the new employer at the time of the hire so it’s difficult for lawyers to give advice about what would happen at Court. 

Susannah Kintish
Yeah, it’s something to be mindful of.  The Court of Appeal agreed with the Court of first instance that Dodd did not induce the breach.  In doing so, Lord Justice Lewison noted that lawyers rarely give unequivocal advice, as you say, Jennifer.  Even if they do, clients always need to appreciate that there is litigation risk.  He stated that if the advice is that it is more probable than not that no breach will be committed, that’s good enough but this case makes it all the more important for employers to ask a new employee about any restrictive covenants they are subject to and to seek their own legal advice on enforceability.

Jennifer Millins
Yeah, it’s something for all employers to bear in mind, I think, that one.  So, the next case we are going to look at is the case of Guest Services Worldwide and Shelmerdine and that looked at the construction of enforceability of post-termination restrictions in shareholders agreements.  The facts of this case involve Mr Shelmerdine, who was a shareholder of and provided consultancy services to Guest Services.  Guest Services were in the business of making maps for the guests of luxury hotels.  And the shareholders agreement contained various restrictive covenants, all of which were twelve months long.  Upon termination of their fixed term consultancy arrangement, Guest Services alleged that Mr Shelmerdine used one of their maps in an attempt to solicit an existing client of the company.  They also allege that he had contact with other clients.  Guest Services sought injunctive relief to enforce the restraints in the shareholders agreement.  The Court of Appeal held quite simply that each of the post-termination restraints was enforceable.  There was no issue with their length because the clauses were in a shareholders agreement and as the Court said, that was made between experienced commercial parties. 

Susannah Kintish
That’s an important point to be aware of and this case reaffirms the distinction between restrictions in employment contracts and restrictions in shareholders agreements.  In the latter type of arrangements, it’s common to find longer covenants, as generally speaking there is more equality in the bargaining power between the parties than in an employment relationship and the contract is seen to have been negotiated in a commercial context.  However, in order to be enforceable, such restrictions will still need to satisfy the test of going no further than is reasonably necessary to protect a legitimate business interest. 

Jennifer Millins
Thank you.  So, I want to look now at a very recent Supreme Court decision that was handed down over the summer.  The case is called Harcus Sinclair LLP against Your Lawyers Ltd and it’s a case in which the Supreme Court allowed an appeal on whether a non-compete undertaking outside of the employment context engaged the restraint of trade doctrine.  Now case is part of a general shift in the Court’s approach in recent years.  There used to be a narrow focus on the contract to assess the reasonableness of a restraint of trade but now Courts seem much more open to considering the surrounding facts and circumstances, as they did in this case.  While outside of the employment sphere, it clarifies the law on the approach of enforceability of restrictive covenants in one key respect. 

Susannah Kintish
Yep, that’s right.  This case involved a funding arrangement for a group action involving over 50,000 claimants against a car manufacturer.  Your Lawyers LLP, a firm of solicitors, intended to act for a substantial number of the claimants in the group litigation.  Your Lawyers sought an agreement for funding from a larger firm, Harcus Sinclair.  No formal collaboration agreement was entered into by the parties but both collaborated informally for several months.  Mr Parker was a solicitor at Harcus Sinclair and he signed, on behalf of his firm, a non-disclosure agreement, in which he agreed not to use Your Lawyers’ confidential information and a non-compete, obligating Harcus not to accept instructions from potential claimants in the group litigation without Your Lawyers’ permission for a period of six years from the date of the non-disclosure agreement.  Harcus later recruited its own group of claimants and commenced group litigation against the car manufacturer on their behalf.  Your Lawyers sought declaretory relief from the Court against Harcus, asserting breach of the non-compete undertaking. 

Jennifer Millins
So, we’ve got a case with a six year non-compete, which seems very long.  What did the Court say about that?

Susannah Kintish
Well, the Court of Appeal ruled the non-compete clause was unenforceable as an unreasonable restraint of trad and contrary to the public interest.  However, the Supreme Court allowed Your Lawyers’ appeal and held that the Court of Appeal had been wrong to determine the legitimate interests of Your Lawyers, solely by reference to the contract.  Instead, the Court should have taken into account the parties intentions and contemplations as to their future relationship when they entered into the contract.  The contract did not oblige the parties to collaborate but that was clearly their intention when they entered into it and as such Your Lawyers had legitimate interest in protecting its own potential group claim.  The Supreme Court also held that while the six year non-compete restriction was long, it was logical and necessary as the duration roughly equated to the limitation period for the claims in the litigation. 

Jennifer Millins
That’s really interesting.  So while it’s outside of the employment sphere, it’s rare that these cases get to the Supreme Court so it’s certainly one to take note of.  So, our final case for discussion is one that the Mishcon team were involved in a while back.  Our colleagues represented the successful employer in Square Global against Mr Leonard.  This case involved Mr Leonard claiming constructive dismissal which means that he purported to resign in reliance on an alleged fundamental breach of contract by the employer.  If established, the contract, including the restrictive covenants, would fall away. 

Susannah Kintish
That’s right.  So, because Mr Leonard claimed that Square had fundamentally breached his contract, entitling him to resign, and as a result, the provisions that would normally survive termination, critically, the restrictive covenants would fall away.  When he resigned, Square confirmed that it had not acted in breach, as Mr Leonard alleged, so it was going to treat Mr Leonard’s resignation as a resignation on notice and Mr Leonard should therefore return to work until the expiring of his notice.  Square told him it was he who was in repudiatory breach by being absent from his duties without authorisation and Square did not accept that breach.  Square confirmed that while the contract subsisted, Mr Leonard wouldn’t be paid because he was absent without authorisation although they made it clear that if he turned up to work, he would be paid.  Square sought a declaration from the Court that Mr Leonard remained an employee until the end of his notice period.  It also sought an order prohibiting Mr Leonard from engaging in competitive activity whilst he was an employee of Square and injunctive relief to enforce the post-termination restrictions.  The Court found in Square’s favour and declared that Mr Leonard remained Square’s employee until the expiry of his notice.  It upheld the restraints on competition during his notice period and it upheld and enforced the full period of the post-termination restrictions. 

Jennifer Millins
So, effectively Mr Leonard was ordered to observe his notice period in full and then the subsequent period of restraint in full.  Because Mr Leonard was not placed on garden leave, the restrictive covenant period was not offset by the notice period.  It’s an interesting point because often employers will think, in the heat of the moment, that they should accept an employee’s repudiatory breach but this approach turned out to be far more strategic. 

So finally, I wanted to talk a little about the Government’s consultation of reforms to non-compete clauses in contracts of employment that was launched earlier this year.  Mishcon was involved in the Employment Lawyers Association’s response to that consultation and as part of this, we surveyed our employer clients for their views on the 37 consultation questions.  We were overwhelmed with the volume of considered responses we received across sectors.  So, first and foremost I wanted to repeat our thanks to all those who responded to our survey and who gave us some very insightful input that we provided to the Government.  So, thank you to all our participants. 

Susannah Kintish
Could you tell us a little bit more about that consultation was about, Jennifer?

Jennifer Millins
Yeah of course.  So, the Government is currently exploring ways to boost innovation and promote flexibility within the labour market.  This is to support the UK’s economic recovery from the impacts of Covid-19.  It’s concerned that non-compete restrictions in particular may act as a barrier to innovation and the consultation specifically sought views on the reform of post-termination non-compete clauses in contracts of employment, as distinct to other post-termination restrictions such as non-solicitation and non-dealing clauses.  And this consultation is highly relevant to employers.  Most employers, over 90% of the respondents to our survey, use or have used non-competes in their contracts of employment, as you would expect.  So the resounding message from our survey is that there is no appetite for significant reform amongst our employer clients.  The Government wants to ban non-competes all together.  Only 27% of our respondents believe they would be able to adequately protect their business interests if the Government introduced a ban on non-competes.  An overwhelming majority believe that a ban on non-compete clauses would have a negative impact on their business, with only 14% believing that the impact would be positive.  While the Government’s intention is to promote innovation and flexibility, the responses echoed concerns that it could have the contrary effect of inhibiting growth.  Many of our respondents recognised that it was a two-way street.  Banning non-competes would make hiring talent easier.  However, concern about the inability to protect their business interests from unfair competition far outweighed this for most respondents.  The Government also floated the idea of mandatory compensation for non-competes.  While many UK employers we surveyed imposed garden leave periods, as you’d expect, this practice for paying for post-termination non-competes is very rare in the UK currently.  Two-thirds of our respondents considered their employees would be more likely to comply with the terms of non-compete clauses if mandatory compensation were introduced.  The issue, however, comes with considering how and what to pay for these sorts of restraints and there has been much debate about how this would work in practice.  Many other jurisdictions do adopt this approach currently though and the Government was interested to hear how it worked in other countries.  A little over half of the employers surveyed considered that they would continue to use non-compete clauses if they were required to pay for them and 64% of respondents believed that their use of other restrictive covenants would increase if mandatory compensation were to be introduced.  And that makes sense.  Most commonly cited were restrictions on poaching staff, soliciting customers and restrictions on dealing with customers and clients, as you’d expect.  Only a quarter of respondents though that they could adequately protect their business interest through restrictions on the use of IP and confidential information alone, which is unsurprising.  It is rare that a business will be adequately protected without post-termination restraints of some sort for senior employees. 

Susannah Kintish
That’s really interesting but I seem to remember that the Government consulted on similar measures a few years ago.  What became of that?

Jennifer Millins
Yeah, that’s right.  Less than five years ago, the Government had concluded no action was necessary on restrictive covenants following a 2016 call for evidence.  At the time, the Government concluded that restrictive covenants were a valuable and necessary tool and do not unfairly impact on an individual’s ability to find other work.  The premise for this latest consultation is very similar, the only difference being that it comes in the wake of the pandemic, however, we have seen no evidence that the pandemic has changed the conclusions of the 2016 call for evidence when the Government decided to leave the law in this area well alone. 

It remains our view and that’s a view shared I think by many practitioners that the Courts do a pretty good job of getting the balance right between the freedom of employees and the rights of employers already.  The Courts have been doing this for centuries and the law in this area is highly refined as we’ve seen.  The Employment Lawyers Association concluded that it is hard to see how legislative intervention could be of any benefit in making that balance fairer.  Our survey tells us that our employer clients would agree with this and that they would not welcome Government interference in this area. 

You can read more on the consultation and Mishcon’s survey responses on our website, if you go to the Employment Team Moves and restrictive covenant page @Mishcon.com. 

Well for now, let’s wrap up there.  I’m Jennifer Millins and I’d like to say a big thank you to Susannah Kintish for joining me for this Mishcon Academy Digital Sessions podcast.  Do look out of the next episode in the series. 

The digital sessions are a series of online events, videos and podcasts, all available at Mishcon.com.  If you have any questions you’d like answered or suggestions of what you’d like us to cover, do let us know at digitalsessions@mishcon.com.  Until next time, take care. 

The Mishcon Academy Digital Sessions.  To access advice for businesses that is regularly updated, please visit mishcon.com.

Join Employment Partners Jennifer Millins and Susannah Kintish as they explore the significant case law developments surrounding post-termination restrictive covenants and review the developments following the Government's recent consultation on non-compete clauses. The podcast draws on their specialist insight to offer practical guidance and key takeaways for employers and employees alike.                                                                                                      

The key cases for discussion include:

  • Quilter Private Client Advisers Limited v Emma Falconer and Continuum (Financial Services) LLP
  • Allen v Dodd & Co
  • Guest Services Worldwide Limited v Shelmerdine
  • Harcus Sinclair LLP v Your Lawyers Ltd
  • Square Global Ltd v Leonard

To coincide with this podcast, we surveyed our employer clients for their views on the government's proposal to reforms to non-competes. As we await news of whether the government will press forward with any of the proposals, we report on our client's views and explain why employers are resistant to change here.

 


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