Stemming the tide

Key employees inevitably have access to a company’s confidential information,
customers and even your best employees to a rival venture, it could spell
disaster.  Can they be stopped?  Henry Clinton-Davies examines some of the
steps that employers can take to retain or at least restrain departing
personnel

The commercial way to prevent employees leaving is by giving them incentives
to stay – either through financial reward or by enhancing their quality of
life. Financial incentives might, for example include the grant of share
options which only vest over several years – so an employee who leaves early
would miss out on the vesting dates. Under The Child Support Pensions and
Social Security Act 2000, an employer operating an unapproved option scheme
whose shares are "readily convertible assets" may now be able to pass
the liability to pay employer’s National Insurance Contributions, (which arise
on exercise of the options), to the employee.

Of course, the obvious way to encourage employees to stay is by ensuring a
good working environment where they feel respected and fulfilled. Quality of
life can be improved by the introduction of flexible working hours and working
practices adapted to suit individual needs. The employer’s goal should be to
ensure that what cannot be offered in cash incentives is made up for in terms
of quality of life.

Although these incentives may help, they are not always enough to protect
against the defection of key employees. Other steps may be needed to protect
the business from damage.

The employment contract

The key to protecting your business and preventing unfair competition by
ex-employees lies in the employment contract. All employees owe their employer
implied duties of loyalty and good faith. But unless an employer can show that
information which ex-employees are using or misusing is tantamount to a trade
secret, or that ex-employees have embarked on a campaign of solicitation of
customers whilst still employed, these implied duties offer the ex-employer
little protection.

It is crucial then to ensure that the contract contains a properly drafted
confidentiality clause and enforceable covenants. All too often confidentiality
clauses are drawn up that are as unenforceable as they are too general or all
embracing.

A properly drafted confidentiality clause:

– Should define what is meant by confidential information with as much
precision as possible. It is not sufficient to state that an employee must not
disclose confidential information per se. For example, rather than stating that
all the information about customers is confidential, which is plainly too wide,
you may want to say that it is customer lists, pricing policy or the
requirements of customers for the company’s products and services which are
confidential.

– The employee should not only be prevented from disclosing information but
from using it for his own purposes.

– Should reflect the fact that confidential information has a shelf life so
that once information is in the public domain, (other than where the employee
deliberately discloses it), its dissemination is no longer restricted.

– Should have regard to the limitations imposed by recent whistleblowers
legislation, contained in the Public Interest Disclosure Act 1998. Under that
Act clauses in contracts that prevent employees from making "protected
disclosures" (from reporting wrong doing through the proper channels) are
void. It could be argued that a blanket confidentiality clause without a carve-out
for protected disclosure could fall foul of this rule.

Garden leave

Another useful device to exert a measure of control over an employee wishing
to leave is to include a garden leave clause in the employment contract. This
enables the employer to suspend the employee during his notice period. The
employer must, however, continue to pay the employee to stay away from the
office. "A good deal for the employee" you may say. Yes, but at the
same time the employee’s access to confidential information and to clients is
restricted.

Many companies seem to think that they can require a departing employee to
take garden leave even without a contractual clause. In most cases they are
wrong, see William Hill Organisation v Tucker, 1998, IRLR 313. As in that case,
forcing an employee onto garden leave in such circumstances will usually be a
major breach of contract. The employee will be able to claim constructive
dismissal and the company will be barred from relying on any other non-compete
restrictions in the contract.

Also, bear in mind that time spent on garden leave is time out of the
market. The courts may now take this into account in determining whether any
other restrictions you seek to impose on employees after they leave are
reasonable. Time spent on garden leave should therefore be set off against the
periods of time which any other restrictions are intended to last.

A garden leave clause:

– Should be reasonable in scope and duration: increasingly the courts are
applying the same tests of enforceability as they do with other restrictive
covenants. Garden leave can only be imposed for a reasonable period of time,
which is not necessarily synonymous with the entirety of an employee’s notice
period.

– Should restrict the employee from working for other companies. If you do
not include this stipulation, you could find yourself in the galling position
of paying the employee on garden leave whilst he receives a second salary
elsewhere, see Hutchings v Coinseed Ltd, 1998, IRLR 190. Even clauses which do
this are subject to the reasonableness test: the court will retain a discretion
as to whether to enforce them and may for example allow an employee to work for
some third parties but not others (see Symbian Limited v Christensen, 2001,
IRLR 77).

– Should restate that the employee continues to owe duties of good faith
whilst on garden leave. At present the courts seem to be in two minds whether
an "implied duty" is applicable.

Restrictive covenants

There are a variety of restrictive covenants that can be included in an
employment contract to protect your business against unfair competition.

Well-drafted restrictive covenants can provide an employer with much needed
protection against key employees who leave to join a rival.

Key considerations in drafting restrictive covenants are:

– Does the employer have a legitimate interest to protect, such as his
confidential information and customer connection, and if so, is the clause no
wider than is reasonably necessary to protect that interest. If in doubt, seek
advice!

– Include a "non-solicitation of customers" clause, backed up by a
non-dealing clause. A company will normally be able to establish that it has a
legitimate interest in protecting its customer connections. Solicitation is
difficult to prove if the customer says, "I voluntarily followed the
employee". The clause therefore needs to prevent the employee contacting
or dealing with customers. It is wise to limit these prohibitions to customers
with whom the employee has recently been in contact (say in the past 12
months). As with all covenants the clause should also be limited to a
reasonable period after the end of the employment, (as a broad rule of thumb no
more than 12 months), minus the time spent on garden leave.

– Include a "non-poaching of employees" clause. A company’s
employees are often a vital asset of the business, particularly if they possess
the skills essential to a business’s success and have influence over key
customers. If a departing employee tries to persuade former colleagues to leave
as well and join a competitor or start up a competing venture – it could be
disastrous. The courts have recognised this as an area that merits protection,
but have set some limitations on the principle. The prohibition can only apply
for a reasonable time. Also, the clause should be limited to key employees in
terms of seniority and expertise, and only include any employees who worked for
the company at the same time as the ex-employee, (TSC Europe (UK) v Massey,
1999, IRLR 22). An exception to the general rule was made in the recent case of
SBJ Stephenson Ltd v Mandy, 2000, IRLR 233, where a non-poaching clause was
upheld, even though it related to all grades of staff. However, that was a case
decided on its own particular facts.

– Include a clause that prevents the employee from working for a competitor.
This kind of clause is the most draconian and, therefore, the most difficult to
enforce. To try and ensure this clause can provide some protection, it must be
very carefully drafted. In particular a clause that prevents the employee from
being involved in any business "in competition with that carried on by the
ex-employer" without regard to what the employee was actually doing would
be too wide to enforce, (as was the case with Wincanton Ltd v Cranny & SDM
Transport, 2000, IRLR 716). Thought should also be given to whether the clause
should only apply in a limited geographical area and whether the period of
restraint should be shorter than the other covenants.

Payments in lieu of notice

When an employee leaves to join a competitor – an employer’s first reaction
may be to want the employee to leave immediately. If this is not provided for
in the employment contract, it could create problems, as the employer could be
in breach of the contract and so lose the right to rely on the restrictive
covenants in the departing employee’s contract. The solution adopted by many
employers is to include a payment in lieu of notice (Pilon) clause in the
contract that allows the employer to terminate the contract immediately with a
payment in lieu of notice. The reasoning is that if the contract contains a
Pilon clause, the employer is not acting in breach of contract in bringing the
contract to a premature end and is therefore still able to enforce the
covenants.

Provided that the clause merely gives the employer the option of terminating
employment with a Pilon, the employer has a choice: he can pay up, require the
employee to leave and enforce the covenants. Alternatively he can refuse to
pay, accept he is in breach of contract and leave the employee to claim
damages. The downside is that the employer must forego reliance on the
covenants. The advantage however is that the employee has no automatic right to
the Pilon. As in the case of Cereberus Software v Rowley, CA, 18 January 2001,
the employee is then under a duty to mitigate his loss and must give credit for
earnings from new employment received during the notice period.

Recently, a rival company sued one of our clients in the High Court. The
rival alleged that two employees, who had recently joined our client, should be
stopped by a court injunction from dealing with their old employer’s customers.
We won. Why? Because the relief sought by the ex-employer went beyond the
protection provided for in the employment contracts his lawyers had drafted.
The lesson is clear – if you would like to prevent ex-employees from enjoying
an unfair competitive advantage, protect yourself in the contract of
employment.

Henry Clinton-Davis is partner and head of the employment and human
resources team at Brobeck Hale and Dorr

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