The reasonableness of restrictive covenants has to be assessed at the time they are entered into, taking into account the proximity of the employee to the business interests that the restrictive covenant seeks to protect. In a recent case, the High Court concluded that this could mean that the restrictive covenants entered into by a junior employee remained valid after her promotion to a more senior role, where she had been specifically head-hunted with the intention that she would be promoted quickly.
The court’s decision does not change the substantive law on restrictive covenants but serves as an overview of the current law and an illustration of the practical application of such terms in similar circumstances.
The facts
EZ, a UK subsidiary of a worldwide group, sought an injunction to prevent a former employee from working for one of EZ’s competitors, based in New York. The employee’s contract included a non-compete clause which prevented her from engaging, being concerned with or interested in any business competing with EZ that she had been involved with in the last year for six months from termination of employment.
The employee, having established a considerable reputation within her field, was hired at entry level by EZ, at which time she entered into the restrictive covenant as part of her contract. However, the employee had quickly risen within the company, reaching the highest level of promotion within five years.
The employee claimed that the clauses within the restrictive covenant were unreasonable on the grounds that:
- EZ’s non-compete clauses were wider than was required to reasonably protect the business;
- the lack of a territorial limit meant the non-compete was unenforceable; and
- preventing 'interest' in another business was too wide as it covered minor shareholder interests.
Reasonable protection?
The validity of a restrictive covenant depends on whether the protection it affords is no wider than is reasonably necessary to protect the legitimate interests of the business.
The nature of EZ’s business meant there was a close relationship between clients and employees, and that there was potential for access to confidential information and clients in foreign jurisdictions. The extent of this access had to be considered when determining the reasonableness of the non-compete clause.
The court held that where the restrictive covenant was being applied to an employee who had subsequently been promoted, it was not the potential for promotion at the time the contract was entered into that was to be considered; rather, the exposure to protectable interests that took place in anticipation of such possible promotion.
The employee had been considered a valuable asset when she was hired, resulting in high expectations of likely promotion. As such, she was afforded greater access to EZ’s clients and confidential information, and provided a more meaningful contribution than was common at her initial level. Therefore, the judge held that enforcement of the non-compete clause was reasonable.
Although there was no explicit territorial limit, the scope was limited by virtue of the fact the restrictive covenant applied to the geographical area of competing businesses the employee had been 'materially concerned' with, and so this too was reasonable.
Additionally, ’interest’ could be interpreted either in the literal sense or as meaning a shareholding. It was held that as another clause in the contract referred to permitted shareholding by employees, the non-compete was not intended to cover this. However, even if it did, post-termination restrictions are generally broader those that apply that during employment. As a result, the more restrictive rules on competitor investment were not unreasonable and would not invalidate the clause.
The implications
Although this decision does not affect the law as it currently stands in relation to reasonableness in restrictive covenants, it illustrates practical issues which ought to be considered by employers.
An employee’s promotion will not impact the assessment of reasonableness as such. Instead, this is to be considered in light of the expected involvement of each employee at the time the restrictive covenant is entered into.
In the circumstances of this case, the expectations on the employee and actions taken by the employer in anticipation of her fast-tracked promotion meant that the restrictive covenants were reasonable at her initial junior level, and on promotion. However, this will not always be the case, and businesses should consider any changes that may need to be made to restrictive covenants following promotion of employees to account for any increased risk to business interests.