restrictive covenants
DESCRIPTION
restrictive covenantTRANSCRIPT
The enforceability of a restrictive covenant is to be assessed at the time at which it was entered into 1
January 2013
Enforcing restrictive covenants: A promotion cannot cure an unreasonable non-compete
The High Court of England & Wales has recently confirmed that a non-
compete clause, which prevented an employee from working for a competitor
for a period of 12 months, was unenforceable at the time it was agreed due to
the employee’s junior position, and that it remained unenforceable, despite
the employee’s promotion to a senior position.1
Facts Mr. Neilly was an employee of Pat Systems, a business which developed
and sold financial trading software to banks and futures commission
merchants. After 12 years at Pat Systems, Mr. Neilly left to join Trading
Technologies, a competing business which operated in broadly the same
market.
Mr. Neilly had joined Pat Systems in 2000 as an account manager with an
annual salary of £35,000. The employment contract that he signed at the time
contained a one month notice period and a non-compete clause that
prevented him from working for any competitor of Pat Systems’ business for a
period of 12 months after termination. By 2005, Mr. Neilly had been promoted
to the role of Director – Global Account Manager. The promotion came with a
substantial pay rise, and a change of his notice period to three months. At the
time of the promotion, Mr. Neilly signed a letter stating that he “acknowledged
and agreed” that, aside from the variations as to pay and notice, all other
terms and conditions in his original employment contract (most notably, the
non-compete clause) remained “unchanged”. By 2012, Mr. Neilly had a key
role with direct global client responsibility and management responsibility for
the EMEA region; his total annual remuneration package amounted to
£191,170.
In 2012, Mr. Neilly gave Pat Systems three months’ notice of his resignation
and stated that he was joining Trading Technologies. Pat Systems notified
Mr. Neilly that he was dismissed with immediate effect and that it intended to
enforce the non-compete clause.
1 Pat Systems v Graeme Neilly [2012] EWHC 2609 (QB)
Contents Facts ................................ 1
Decision ........................... 2
Remedies ......................... 3
Implications ..................... 3
The enforceability of a restrictive covenant is to be assessed at the time at which it was entered into 2
Decision The court had to decide (i) whether the non-compete clause was applicable to
the employee’s proposed employment with Trading Technologies; (ii) if so,
whether the non-compete clause was enforceable; and (iii) whether the
employer could rely on the non-compete clause given its summary dismissal
of the employee.
Was the non-compete covenant applicable to the proposed employment
with Trading Technologies?
Yes – Pat Systems and Trading Technologies were competitors in that they
were both sellers of financial trading software and sold products to the same
class of customer, i.e. banks and futures commission merchants. The court
considered the nature of both businesses and concluded that both
businesses sought professional traders as clients, and sought to promote the
use of its products by end users.
Was the non-compete clause enforceable?
No – The starting point is that enforceability of a restraint is assessed by
reference to its reasonableness at the date at which it is entered into. The
court held, and Pat Systems conceded, that the non-compete clause was not
valid at the time it was entered into because a 12 month non-compete clause
was excessive for a junior employee and went beyond what was reasonably
necessary to protect the employer’s legitimate interests at that time.
As to whether the employee’s promotion could subsequently make the
restrictive covenant enforceable (because of the employer’s enhanced need
for protection of its business), the court found that if a restrictive covenant
was not valid from the outset, it could not become valid by virtue of it being
reasonable because of the employee’s promotion and increased seniority. If
the employer seeks to rely on the protection of the original restrictive
covenant, the covenant must be expressly reaffirmed.
Here, there was no specific reaffirmation of the non-compete clause at the
time of the employee’s promotion. The employee’s acknowledgment in the
2005 promotion letter that the existing employment terms and conditions
remained unchanged did not amount to a specific reaffirmation of the non-
compete clause. What was needed was evidence of the parties’ contractual
intention to reaffirm the clause at that time. Therefore, assessed at the
original date, the non-compete clause remained unenforceable in spite of the
employee’s promotion.
Further, the court stated that the duration of the restriction would have been
too long. A six-month non-compete clause would have been sufficient to
mitigate a competitor’s potentially unfair advantage from employing Mr. Neilly.
This was because (arising from its access to Mr. Neilly’s trade connections
and knowledge of confidential information) the market was fairly transparent
with regards to pricing and product information and Trading Technologies
would have already been dealing with many of Pat Systems’ customers. The
The enforceability of a restrictive covenant is to be assessed at the time at which it was entered into 3
court was also influenced by the fact that colleagues of Mr. Neilly, who also
had access to confidential information and comparable trade connections,
were only subject to non-compete clauses of no more than six months.
Was the employer entitled to rely on the non-compete clause to
summarily dismiss the employee?
No – The court held that Pat Systems could not summarily dismiss Mr. Neilly
due to an anticipated breach of the non-compete clause. The fact that the
clause was unreasonable, and thus unenforceable, meant that his dismissal
was wrongful.
Remedies The court dismissed Pat Systems’ claim and did not grant injunctive relief in
the terms of the non-compete clause. Mr. Neilly’s counterclaim as to wrongful
dismissal was allowed and an assessment of damages was ordered.
Implications for employers Express reaffirmation or fresh agreement:
The employer and the employee should expressly renew any restrictive
covenants (e.g. by way of a reconfirmation or restatement letter) to take effect
from the time at which the employee is promoted. The parties should also
acknowledge that the employee’s consent is given regardless of whether the
original restrictive covenant was enforceable up until the point of the
promotion.
Alternatively, the employer and the employee should sign a fresh employment
contract to reflect the terms of the employee’s promotion, and in particular,
any relevant restrictive covenants. This is of particular importance where the
employee’s role is key to the employer’s business.
Regular assessment:
The employer should conduct regular assessments as to the effectiveness of
its restrictive covenants to ensure that they are enforceable and accurately
reflect the employee’s role and obligations. Where the employee is promoted
or his role changes, the employer should consider whether it is necessary to
tailor the restrictive covenants at this point in time.
The enforceability of a restrictive covenant is to be assessed at the time at which it was entered into 4
A16100547/0.9/25 Jan 2013
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