Restrictive covenants & beyond

Introduction

When key executives or founders leave a business, it is understandable that the owners would want to ensure that the departing individuals don’t misuse contacts and confidential information in ways that could damage the business. The higher profile of the departing individual the greater the levels of anxiety about the potential damage they could cause. A lot of time, effort and emotional energy can be spent devising a set of restrictive covenants to prevent or at least mitigate any damage.

Most people are reasonable, and more often than not, contracts are put away in a drawer and everybody gets on with their lives. Now and again, however, owners may be alerted to potential breaches and have good reason to go back and look hard at the wording of any restrictive covenants.

What happens first?

The owners have heard from a reliable source that the individuals are engaging in just the sort of activities which the owners feared they might, and this is hurting the business. There is likely to be a strong reaction from the owners, and yet it will be important to focus on establishing the facts.

Not only is it necessary to be able to demonstrate that a breach has occurred, but also to show in what way this is damaging the commercial position and goodwill of the business.

What is the scope of the restrictive covenants?

Typically, restrictive covenants will cover the following activities:

• Non-compete with the business
• Non solicitation of customers
• Non solicitation of suppliers/others contracting with the business
• Non solicitation of employees
• Wrongly suggesting an ongoing relationship with the business

Are they enforceable?

In order to be enforceable, restrictive covenants must be reasonable and necessary to protect the goodwill of the business. This is why there is invariably a clause stating that the parties all agree that they are necessary and reasonable, but this does not of itself always assist enforceability.

Quite often there will be some “mission creep” in scope and the covenants may end up being much broader than necessary, groupthink can be a problem. Typical issues with the scope of covenants include:

• Time limits – more than 12 months is hard to justify
• Geographical limits – these should reflect the activities of the business
• Definitions of competing businesses – this is often a problem area, it is reasonable to limit this to the current activities of the business but not include other potential plans
• The role of the former exec/founder – what sensitive information do they have?
• Did the former exec/founder receive independent legal advice?

Beyond

It is never a nice experience to have to go back and look hard at the language in the context of an alleged wrongdoing and the potential impact on the business. Below are some principles to bear in mind when drafting restrictive covenants, but also more broadly in drafting many other contract terms:

• • Don’t overcook the restrictions, they need to address the potential threats to the business, resist groupthink
  • Be very specific about what constitutes competition, even stating the names of competitors if there are clear and obvious candidates that are key to the business
  • Courts will be reluctant to prevent people from working, so consider what time or geographic limits can really be justified to protect the interests of the business
  • With geographic limits, although “global” may sound good, there is likely to be a problem with enforcement
  • Consider the role of the individual – limiting the restriction to those areas of the business’ operations that they were personally involved with in the 12 months before their departure
  • The individual should be required to take independent legal advice. It makes sense to insist on this if possible and have their lawyers certify that they have advised

You can’t legislate for everything in a contract, but it is important to be realistic about the limits to the enforceability of any contract terms. It is important to recognize that there may be a gap between the terms of a contract, and the practical reality of enforcement.

If you’d like some help with restrictive covenants, please get in touch.