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Case update (2): Restrictive covenants – non-compete clauses

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Summary: Can a 12-month non-compete restrictive covenant in a service agreement and shareholder agreement prevent a (senior) solicitor from joining a competitor?

Yes, says the High Court in Law by Design Ltd v Ali (available here) if the clause goes no further than is reasonable to protect a legitimate business interest.  In this case the clause in the service agreement was reasonable and enforceable, but the clause in the shareholder agreement was not.

Background: Post-termination restrictive covenants are clauses which restrict an ex-employee’s ability to compete with the employer for a certain period. These clauses will be void (for being in restraint of trade) and unenforceable unless the employer can show it has a legitimate business interest to protect and the clause goes no further than is reasonable to protect it.

These covenants are generally contained in employment contracts, directors service agreements, settlement agreements or commercial contracts (such as shareholder agreements). Usually covenants in shareholders agreements are more likely to be considered reasonable and enforceable than in employment contracts because they are negotiated in a commercial context and there is a relative equality in bargaining power between the shareholders.

There are different kinds of restrictive covenant depending on what business interest an employer is aiming to protect. To stop employees joining a rival or setting up in competition a ‘non-compete’ clause is needed. As these clauses can be very restrictive on an employee’s ability to find work, they are generally more difficult to enforce than other restrictive covenants, such as those which restrict dealing with customers or soliciting employees.

If an ex-employee is not willing to comply with a non-compete clause, the employer can seek an injunction from the court to enforce compliance. However, the court will only do so if the clause goes no further than reasonable to protect its legitimate business interest.

Facts: The employee, Ms Ali, was employed by Law By Design Ltd (a small boutique law firm focusing on employment law work for mainly NHS employers in the North West of England).

In 2016, Ms Ali entered into a shareholders agreement that included a non-compete restrictive covenant. This said that she could not be engaged, concerned or interested in, or assist, a business which competes, directly or indirectly, with a business of the company in an area in which it had operated in the previous 12 months.

In 2018, Ms Ali was promoted to director and in January 2021 she signed a new service agreement which contained a 12-month non-compete clause. Ms Ali received a substantial pay rise in return for signing the agreement. The non-compete clause prevented Ms Ali’s involvement in a ‘restricted business’ for 12 months after the end of employment (meaning ‘any company in competition with Law By Design in the areas Ms Ali had been involved to a material extent in the 12 months prior to the termination of employment’). This was a narrower non-compete restriction than in the shareholders agreement.

In May 2021 Ms Ali resigned (with six months notice) to work for a national law firm which also provided services to NHS clients in the North West of England.  She also  prepared a seven-page business plan in which she referred to ‘transitioning’ clients generating annual fee revenue of around £250,000 (over a third of its annual turnover) from Law By Design to her new employer.

When Law By Design asked Ms Ali to agree to comply with the non-compete restrictive covenants in both her shareholder and service agreements, she refused on the basis they were unenforceable due to their broad scope and duration. Law By Design applied to the court to enforce both covenants.

High Court decision

The High Court granted an injunction to enforce the non-compete clause in the service agreement. However, it did not do so in respect of the shareholder agreement (even though these are usually more enforceable).

The restriction in the service agreement was enforceable because:

  • Law By Design’s customer connections with NHS bodies in the North West of England amounted to a legitimate business interest;
  • It was no wider than was reasonably necessary to protect that business interest. In particular, the restriction only affected the parts of Law By Design that Ms Ali had recently been involved with to a material extent;
  • Its 12-month duration was necessary for Law By Design to re-establish its legal and commercial relationships with its NHS clients in that geographical area (including finding another lawyer to replace her); and
  • It was necessary to protect Law By Design’s interests. Ms Ali had demonstrated in her business plan (to remove more than 30% of Law By Design’s client base and fee income) that she intended to do just what the non-compete clause was designed to prevent.

The non-compete covenant in the shareholder agreement was void (and not enforceable) because:

  • It was wider than was reasonably necessary for Law By Design to protect its legitimate business interests. This was because it prevented any competition (directly or indirectly) with Law By Design across England and Wales and this was too broad in area and type of work.

The fact that the covenant was in a shareholder agreement was not the issue. Even if it had been in the service agreement, it would not have been enforceable.

Implications: Good news that a 12-month non-compete restrictive covenant in a service agreement can be enforced. In particular those drafted tightly with close reference to the specific business interests to be protected.

Although the context was helpful to the employer (the employee was senior and understood what she was signing up to) it was the drafting that largely made the difference; the seniority of the employee did not stop the non-compete clause in the shareholders agreement from being unenforceable.

However, it is important to note going forwards that the Government has proposed to limit the enforceability of non-compete clauses (or even to ban them). We updated you in our December 2020 Newsletter Government reforms (1): Non-compete clauses – consultation on this and we are still waiting for the Government’s response to its consultation.

Return to Menzies Law Newsletter 2022 Issue 2

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