Will the law change on restrictive covenants?

How
should employers react to a recent case that casts doubt on when restrictive
covenants are enforceable?

In the ever-changing world of employment law, one old principle holds true –
if an employer commits a serious breach of contract which brings the employment
to an end, any restrictive covenants in the employee’s contract will not be
enforceable. That principle may be set to fall.

Typically, restrictive covenants include prohibitions on employees using or
disclosing confidential information, soliciting or dealing with customers or
suppliers and poaching key staff, all for a limited period. They allow the
employer to try to protect their business interests in the immediate aftermath of
the employee’s departure.

If the employee breaches any of the covenants, the employer can sue for
damages and possibly seek a court injunction.

But because restrictive covenants are a bar to free competition, the courts will
only uphold them if they are necessary to protect an employer’s legitimate
business interests: a badly drafted covenant which is excessively restrictive
is likely to be unenforceable.

However, the most beautifully crafted restrictive covenant may be of no use
if the employer ends the employment in the wrong way.

The decision of the House of Lords in General Billposting Co Ltd v Atkinson,
1909, AC 118, established that, if the employer commits a repudiatory breach of
the contract (in other words, a serious one) in dismissing the employee, or if
the employee resigns due to the employer’s repudiatory breach, the employer
will be precluded from relying on the post-termination restrictions in the
contract.

Generally, this has been taken to mean that an employer will be unable to
enforce the restrictive covenants if he dismisses the employee without the
required notice, even if he pays the employee his salary and benefits in lieu,
unless the contract expressly permits this by containing a ‘pay in lieu of notice’
clause (a PILON).

The alternative view, which has found some sympathy in the courts, is that
the dismissal without due notice, but with a payment in lieu, is a breach of
contract if there is no PILON, but not a repudiatory one.

This was the approach taken recently by the Employment Appeal Tribunal in
Scotland in MacKenzie v CRS Computers Ltd (unreported, 25 April 2002). The case
concerned the enforceability of contractual provisions (but not restrictive
covenants) at termination of employment. Mr MacKenzie was dismissed without the
two weeks’ notice required by his contract, and was paid in lieu. Even though
there was no PILON in his contract, the EAT held there was no material or
repudiatory breach of his contract because, by being paid in lieu of notice, he
was in no worse position than he would have been in had notice been given.

It remains to be seen whether this approach will be sustained by the higher
courts.

Key points

– Restrictive covenants are important when employers try to
protect their business interests from competition after employees leave

– Covenants must be drafted with care and ideally with informed
legal advice

– Covenants could be unenforceable if the employer terminates
the contract without the requisite notice, unless there is an express
contractual right to pay the employee in lieu of notice

– Until the issue has been determined by a higher court,
employers should not assume the decision in MacKenzie means that restrictive
covenants will now be enforceable where employees are dismissed without notice
and paid in lieu in the absence of a contractual right to do so

Nicholas Moore, Head
of Employment, Osborne Clarke

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