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Government call for evidence: are restrictive covenants a barrier to innovation?

Posted on 7 July 2016

Government consultation: are restrictive covenants a barrier to innovation?


Are your employees signed up to restrictive covenants preventing them from competing when they leave you? Have you ever had difficulty employing someone because of their restrictive covenants with a previous employer? Have you ever been involved in a restrictive covenant dispute?

The answer to at least one of these questions is likely to be yes. A recruitment business is built on relationships. These relationships are investments which require protection, and recruitment businesses rely heavily on restrictive covenants for this protection. For this reason, it is important that the government hears the recruitment sector's views as part of its recent "call for evidence" on this subject.

The government is considering legislating on restrictive covenants. This recent proposal was made alongside a raft of other measures which, the government says, will promote innovation and flexibility within the labour market through The National Innovation Plan. Specifically, the government is seeking views on whether restrictive covenants stifle innovation by preventing people from moving between employers and setting up and growing new businesses. See box below for details of the views and information that the government is seeking.

The call for evidence is open until 19 July 2016. It covers all employee restrictive covenants, including restrictions on soliciting and dealing with suppliers and customers, restrictions on poaching employees and non-competes.

How are restrictive covenants currently kept in check?

Restrictive covenants are creatures of contract, but the common law has regulated their use in this country for centuries. There is a raft of ever-evolving case law governing the enforceability of restrictive covenants and it is perhaps difficult to see how legislation will assist in what is already a highly "regulated" area of the law.

The courts, applying the common law, currently ensure that covenants do not stifle innovation in the employment arena by applying what is known as the doctrine of restraint of trade. The starting point for this doctrine is that a restrictive covenant will be void as a restraint of trade, unless it goes no further than is reasonably necessary to protect a legitimate business interest of the employer. This means that the former employer seeking to enforce the restriction must demonstrate that it has a legitimate business reason to enforce the covenant, and that it is reasonable in scope, area and timeframe. This involves a careful balancing act of the interests of all parties.

A need for certainty?

The government has suggested that one benefit of legislating in this area may be certainty. Case law can be complex and there are no guarantees as to whether a court will uphold a restriction in any given case. Most recruitment businesses will have seen restrictions that go further than necessary: do recruitment businesses feel that uncertainty as to whether restrictions are enforceable is an unfair deterrent to innovation?

Would the recruitment industry welcome guidance on the use of restrictive covenants, and is more certainty needed? Legislation itself would no doubt leave a raft of cases in its wake as businesses grapple with the interpretation and effect of new laws. Far from creating certainty, would legislation create a more uncertain environment for recruitment businesses?

Unintended consequences?

A statutory ban on restrictive covenants may well have the opposite effect to that intended by the government. Outlawing restrictions would only deal with one side of every restrictive covenant dispute: that of the defendant who is seeking to compete, and the new employer who wishes to hire him or her. What about the innovation of the former employer? Innovation may be well and truly stifled if employers cannot impose reasonable, short restrictions on departing employees to protect their confidential information, business relationships and the stability of their workforce.

Crucially, who will invest in British innovation that is not adequately protected?

Permanent recruiters in particular will also need to think about how this might affect their clients. Clients will expect to be able to protect their businesses from unlawful competition by imposing restrictions on those employees that recruiters place with them.

A statutory ban on restrictive covenants could even result in additional expense for employers: in jurisdictions where the rules on restrictive covenants are tighter, or where they are banned altogether, it is common for employers to pay to stop employees setting up in competition or walking away with key relationships.  This could result in significant expense for larger employers – and may not even be an option for smaller businesses. Conversely of course as, any recruitment business that has been through one will know, restrictive covenant disputes are a distraction for the business and can be costly.

What should you do in the meantime?

For now, recruitment businesses that wish to protect their innovation should continue to focus on carefully drafted, tailored restrictive covenants that the courts will enforce.

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