Key tips for avoiding errors when drafting restrictive covenants

Covenants

Restrictive covenants are one of the key weapons in the fight against unlawful competition by former employees. Drafting enforceable restrictions has always been challenging, but the importance of investing time and effort to get it right cannot be overstated.

Kate Brearley and Kiersten Lucas from Stephenson Harwood LLP look at the implications of a recent case and provide key tips for avoiding errors when drafting restrictive covenants.

The draftsman’s job is not easy: he must strike a delicate balance between prohibiting competitive activity to the maximum extent possible without compromising the prospects of enforceability. Covenants can only protect legitimate business interests, and go no further than is reasonably necessary to do so. It is therefore critical to have a detailed understanding of the nature and extent of the employer’s business and employee’s role in it, and to reflect this in clear drafting. Understanding how the courts approach the interpretation of covenants, and the limited circumstances in which they might assist when the drafting goes wrong, is also key.

In recent years, the courts have tried to apply a degree of commercialism when interpreting covenants, rather than rendering them unenforceable by a stricter, more literal construction. However they have still drawn a firm line between severing (“blue pencilling”) words to leave behind an enforceable restriction or interpreting covenants in such a way that they can be upheld (which is permissible), and re-writing covenants (which is not).

In July 2014, the Court of Appeal (CA) in Prophet Plc v Christopher Huggett confirmed that this remains the correct approach.

The High Court and Court of Appeal decisions

Clause 19 of Huggett’s employment contract with Prophet contained the following 12-month covenant:

“The Employee shall not… directly or indirectly, carry on, or be engaged, concerned or interested in any business which is similar to, or competes with, any business of the Company in which the Employee shall have worked whilst employed hereunder (in that they provide computer software systems of whatever kind to any company involved in the fresh produce industry) within the geographical area (namely the United Kingdom)…”

Both parties acknowledged that this part of the covenant would be unenforceable if it stood alone. The issue was how to interpret the following proviso:

“Provided that this restriction shall only operate to prevent the Employee from being so engaged, employed, concerned or interested in any area and in connection with any products in, or on, which he/she was involved whilst employed hereunder.” (emphasis added)

Read literally, this gave Prophet no practical protection whatsoever: Huggett had only been “involved” with two Prophet products, which were unique to Prophet and would never be sold by his new employer, K3 Business Solutions Ltd (K3), or any other firm.

The High Court judge sought to provide a commercially sensible result by adding the words “or similar thereto” to the proviso, so that it applied to more than just Prophet’s products. However, any glimmer of hope for employers that this meant the courts were now prepared to effectively re-write covenants where something had clearly “gone wrong” with the drafting, was quashed by the CA.

In the CA, Lord Justice Rimer acknowledged that where the wording of a contractual provision is clearly ambiguous, the court will generally favour an interpretation that leads to a commercially sensible solution over one that leads to apparent absurdity; however, this was “manifestly not such a case”.

Nothing had “gone wrong” with the drafting of the proviso – the draftsman had chosen his words “with deliberate and specific care”; if anything had gone wrong it was that the draftsman had not thought through the extent to which the wording would (not) actually confer any practical benefit on Prophet. It “was not for the judge nor… this court to re-make the parties’ clause 19 bargain. Prophet made its clause 19 bed and now it must lie upon it”.

Tips for drafting restrictive covenants

There can be no exhaustive drafting checklist, but the following factors should always be considered:

  • Identify and clearly define the business, including:
    • core activities and products/services, including what constitutes “competing” activities/products/services that would cause the business harm, and the level of the employee’s involvement in each;
    • key customers (existing or prospective), suppliers and staff, including the employee’s degree of contact/involvement with them, for what purpose and how frequently; and
    • the trade secrets and confidential information capable of protection.
  • Avoid blanket bans. Where possible, define the precise activities that are restricted and/or carve out those which are not; and limit covenants to clients, suppliers or staff with whom the employee (or those he supervised) had material dealings in a specific window, pre-termination.
  • Identify where geographically the business is carried out and where the employee works: list restricted territories, rather than using terms like “the UK” or “Asia Pacific” (otherwise it will not be possible to sever inapplicable territories and the entire clause may fail).
  • The courts have no power to reduce the agreed duration of a covenant so elect the shortest period that will provide meaningful commercial protection (the shelf-life of confidential information or frequency of contact with clients can be good indicators of what this should be) and offset garden leave periods.
  • Finally, keep covenants under regular review because these factors will likely change over time, for example, because of promotions or expansion into new territories or activities.

About Kate Brearley and Kiersten Lucas

Kate Brearley is head of employment and Kiersten Lucas is a senior associate in the employment team at Stephenson Harwood LLP.
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