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Start-ups and break ups

Posted on 1 June 2021

In a time of change what are the legal consequences for employers and employees?

As the country comes out of the COVID-19 pandemic and the world starts to return to a form of "normal", many people across a wide range of industries are considering leaving their existing employment and setting up their own businesses. This can be seen particularly in the real estate agency business, where a number of teams have left the established mega-agents, spawning new agencies in the past year. According to Companies House data, in the last 12 months, the number of newly-incorporated companies has risen by 23% compared to the 12 months before COVID-19, demonstrating a record number of start-ups being established.

People are seizing the opportunities in the belief that the bottom of the cycle is behind us, that economic recovery is imminent, and that now is the time to leave the confines of their existing roles and set up business themselves. But both employees and employers who are affected should seek legal advice at an early stage.

Preparing for departure

Employees will need to carefully consider the duties and obligations to their current employers. The relevant provisions will be found in the employment contract – and it should be noted that it is rare that redundancy changes the obligations on departing employees. As well as obligations relating to confidentiality, there are likely to be a number of restrictive covenants which are intended to protect the employer’s business from departing employees - in particular, there may be provisions prohibiting an employee from competing with his or her employer during and after employment and, following its termination, from soliciting clients and poaching staff.

Contacting clients

In many cases, employees will only be willing to take the risky step of foregoing a regular monthly pay cheque for a start-up operation (and in the first year, a minimal income) if they know that their clients are likely to join them. Inevitably they will have made informal approaches to their closest clients to gain comfort that they will be followed to the new venture. Clients on occasion will also approach the employee to see if they are willing to leave their employment and set up on their own in order to reduce cost, while keeping the same personalised level of service.

However, employees who discuss their future plans with clients are likely to be acting unlawfully and it is easy to get caught. There are numerous examples where employees believe that their googlemail or personal accounts through which they have made their departure arrangements are secure, only to find that the employer is aware of their plans to depart, for instance because they have seen emails sent from an employee's work address to a personal address, or because clients have inadvertently sent emails about the new venture to the employee's work address. The employer may then suspend the employees and threaten to injunct the new venture from commencing business. We have experience where employers have also notified potential funders of the new business that the departees are subject to enforceable restrictions in favour of the employer - and that the proposed funders would be inducing a breach of contract if they continued with their funding.

This is not the best start for a new venture. Experience shows that where a well- funded employer wishes to enforce its rights as a point of principle and to scare off other potential departees, suspension from the business, threatening solicitors’ letters and the threat of an injunction (with all the associated costs) may mean that the new venture never gets off the ground. Often, the departing employees are also unable to continue with their existing employment.

In addition, teams planning to leave together to join a new start-up or a rival must take extra care to ensure that they are not in breach of their obligations to their employer, which will usually be the case if employees discuss plans together before departure, or if one of the team acts as a recruiting sergeant for the new venture. Recent case law confirms the courts’ willingness to protect employers in this situation.

Legal structure for the new business

One option for a start-up is to use a Limited Liability Partnership (LLP) structure, as opposed to limited companies. LLPs allow members (partners) to enjoy the same tax status as if they were partners in a partnership, while affording them limited liability protection. Another important benefit is the saving of up to 13.8% for employers’ Class 1 National Insurance contributions on members’ salaries - although there are now tests that have to be met to ensure that the members are true "partners" and take the risks as well as rewards of partnership. An LLP agreement will also need to be negotiated among the members.

Compromise with employers - negotiation

Regardless of the restrictions imposed on employees, once the sense of betrayal and disloyalty has passed, employers often realise that, while they may legally be able to prevent the departee from working for their clients, they cannot force their clients to continue to instruct them.

In many cases, the employers are multi-disciplinary organisations that work with their clients in a number of areas, and the start-up can only cover one aspect of the work. The relationship between employer and client could be harmed if the employer treats its employees badly.

After any hostilities have been overcome, arrangements for fee-sharing, mutual referrals, consultancy agreements and permissions to take junior staff are all matters for potential negotiation.

If you'd like to discuss any matters relating to this article please contact Dean Poster or your usual Mishcon contact.

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