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Beware of going overboard on non-compete clauses

Published on Friday, 07 Feb 2014
Kathleen Healy

The Background
In uncertain times, protecting employee talent is firmly at the top of employers’ priority lists. Critical to this is ensuring that “best in class” protection is in place in employment contracts of key staff, to prevent them from being able to damage the business if they leave to join a competitor. Contracts of employment for senior management or key staff usually contain one or more post-termination restrictions. Generally, these are designed to limit the ability of those employees to compete with their former employer for a specified period of time. Increasingly though, employers are finding that careless drafting or poorly planned provisions mean that such restrictions are unenforceable.

Recent media attention in the Asia press about a couple of prominent businesses and their enforcement of non-compete clauses should refocus the attention of all companies on their own employment contracts.

The Issues Involved
When considering your post-termination restraints, it’s useful to get back to basics. The starting point is that a contractual term restricting an employee’s activities after termination is void for being in restraint of trade and contrary to public policy. The only exception to this is where an employer can show both that it has a legitimate proprietary interest to protect, and that the restriction imposed is reasonable in having regard to the interests of the parties and the public interest.

Put another way, before agreeing a post-termination restriction with an employee, an employer should ask itself what exactly it is trying to protect and to what level it needs to restrict an employee in order to feel secure.

An employer cannot impose a covenant simply because it does not want a former employee competing with it. What it can do is seek to stop the person using or damaging something that belongs to the employer.

Broadly, the rights that a court will allow to be protected fall into two categories: trade connections (with suppliers or customers) – or, more generally, goodwill – and trade secrets and other confidential information.

The golden rule is that, if there is a legitimate interest to protect, the employer should impose a restriction that is no wider than necessary to protect that interest. This involves limiting the covenant not only by reference to the restricted activities themselves, but also by reference to the period and – if appropriate – the geographical extent of its application. Failure to do so may result in the covenant being treated as having too wide a scope and hence, potentially void.

When deciding the appropriate period for a restriction, it is necessary to consider how long the competitive activities by the individual are likely to materially threaten the employer’s legitimate interest. For example, for a sales employee, how long will it be before his or her knowledge of their former client’s needs are out of date?

Employers must also consider what type of restriction is appropriate. While many senior contracts contain a provision which purports to restrict an employee from joining a competitor for a certain period, pure non-competes like this can be tough to enforce. In order to enforce a non-compete, employers must generally show that it isn’t possible to give the proprietary interest – for example, a trade secret – adequate protection via normal confidentiality provisions or other less restrictive terms.

Examples of this are where it can be shown that it might be inevitable the employee will use such information in any future employment, or where their influence over customers or suppliers may be so great that the only effective protection is to ensure that they are not engaged in a competing business.

The Points to Remember
Businesses tend to be too ambitious with non-compete clauses. Consider alternatives like a confidentiality clause, or one-stopping an ex-employee dealing with existing customers. Remember to factor in local law considerations. In the mainland, non-compete covenants are unenforceable if there is no payment for the period of restriction.

Finally, it is vital to remember that employers cannot take a “one size fits all” approach. The sort of restrictions that are appropriate for a director of marketing who deals directly with clients is inappropriate for a director of finance, who has no reason to speak to an external client. Different circumstances demand different contractual structures.

The good news is that with some forethought and careful drafting, there are tools for an employer to protect their business interests from former employees who seek to compete. The key to doing so is giving careful consideration to what is appropriate for the individual at the outset and to keep such provisions under regular review whenever there are promotions or other business changes.

Kathleen Healy is a partner in Freshfield’s expanding Employment, Pensions and Benefits practice in Asia. Based in Hong Kong, she specialises in advising on Asia-Pacific employment and HR projects, and on the multijurisdictional employment aspects of internal investigations.

The information contained in this article should not be relied on as legal advice and should not be regarded as a substitute for detailed advice in individual cases. If advice concerning individual problems or other expert assistance is required, the service of a competent professional adviser should be sought.

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