Do non-compete clauses work?

Non-compete clauses and restrictive covenants (also known as post-termination restrictions) are clauses in an employment contract or a Settlement Agreement that prohibit a departing employee from taking clients or key employees from their former business or working for a competitor. Only a valid economic interest can be protected by an employer, and the restrictions must be clearly specified to be reasonable.

The recent High Court decision in Law By Design Ltd v. Ali caught my eye this week as it provides an overview of the factors to consider when looking at the enforceability of post-termination non-compete restrictions, entered into as a shareholder and those entered into as an employee.

Here, the case revolves around an individual who had given 2 covenants:

  1. a restrictive covenant in a shareholders’ agreement which provided 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 the business had operated in the previous 12 months; AND
  2. a 12-month non-compete clause in a service agreement which prohibited them from being involved in any business that was in competition with her employer and specifically the areas in which they had been involved to a material extent in the 12 months prior to the termination of their contract.

The High Court concluded that the business had a legitimate business interest to protect, granted an injunction to enforce the non-compete in the service agreement, but decided that the restriction in the shareholders agreement was too widely drafted to be enforceable.

The key here was that covenant 2 above was narrower than covenant 1, which the Court concluded was unenforceable, on the basis that it was too wide to be reasonably necessary to protect the legitimate business interests of the business.

This is interesting as usually, non-compete clauses in shareholders agreements are more likely to be considered reasonable and enforceable.

The main reason for this is that it is assumed that the parties would have greater equality in bargaining power, as compared with the employer/employee relationship.

However, put simply in this case, the restriction in the service agreement was more narrowly drawn and, ultimately, more enforceable.

As a rule, non-compete restrictions can be notoriously more difficult to enforce and even if an employer can establish a legitimate business interest, it is important that any non-compete clause is drafted so that it is no wider than is necessary to protect that interest.

If the shareholders agreement restriction wording had been in the service agreement, it seems that the injunction would not have been granted.

We are aware of a government consultation on the use of non-compete clauses, which closed last year, but the outcome has not yet materialised.

Possible measures included:

  • Making non-compete clauses in contracts of employment enforceable only where the employer provides compensation for the period that the clause prohibits the individual from working for a competitor or starting their own business; and/or
  • Banning non-compete clauses altogether.

We await whether the outcome of this will see the light of day….

Regards to all,