RESTRICTIVE COVENANTS FROM A UK PERSPECTIVE. Matthew Cole Prettys. ABA International Labor & Employment Law Committee Midyear Meeting

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1 RESTRICTIVE COVENANTS FROM A UK PERSPECTIVE Matthew Cole Prettys ABA International Labor & Employment Law Committee 2010 Midyear Meeting Swissotel The Bosphorus Istanbul, Turkey May 9-13,

2 1. RESTRICTIVE COVENANTS (GENERAL) A. Governing Legislation The United Kingdom has no codified or statutory regime governing restrictive covenants. The law has developed by the application of the general common law principles of tort and contract, and of equity (particularly with regards to remedies). The law is a product of judges, and is still highly influenced by 19 th century concepts of freedom of contract, and the principle that freedom to compete should be unfettered. A substantial body of case law has developed that deals with restrictive covenants in the context of the employment relationship, but it is important to note that exactly the same legal principles apply to other legal relationships and transactions: to the terms on which a business or company is sold, for example, or what happens following the termination of a distribution agreement. Restrictive covenants are very much perceived as part of the commercial relationship between the employer and employee, and tends, primarily to be the province of senior employees. Consequently, trades unions have had little involvement or influence over the direction of the law in this area. There is a marked contrast between the rights of an employer during the employment relationship as compared to what happens after that relationship has terminated. 1) Applicable Treaty of Convention The United Kingdom is a member of the European Union (EU) and is therefore bound by the Treaties and Conventions applicable to all member states. Whilst these have a significant effect on regulating every member states employment laws (particularly with regards to discrimination and health and safety), they do not have a significant effect upon the law as it applies to restrictive covenants. However, they do have a bearing on enforcement of judgements. In particular the EU Council Regulation on Jurisdiction and the Recognition and Enforcement of Judgments in Civil and Commercial Matters 44/2001 binds EU member states as to the applicable jurisdiction in international disputes. The EU also binds member states when considering choice of law issues (see EU Regulation 593/2008 on the law applicable to contractual obligations, known as the Rome I Convention ). However, away for the issue of international disputes, the United Kingdom s treaty obligations have little effect on the law with regards to restrictive covenants. 2) Applicable Statutes and Rules (general) As has been mentioned above, the United Kingdom has not codified its laws insofar as they apply to restrictive covenants, and therefore there is no one statute of particular relevance. However, individual statutory provisions can have an impact upon the law in this area. These are referred to throughout the Chapter, where relevant. In particular, the Human Rights Act 1998, enacted so as to give specific effect to the European Convention on Human Rights (the ECHR ), has affected the development of the right to privacy, as have the Data Protection Act 1998, the Regulation of Investigatory 2

3 Powers Act 2000 and the Telecommunications (Lawful Business Practice) (Interception of Communications) Regulations 2000 (SI 2000/2699). This body of law has fundamentally affected the development of the law of surveillance at work. Copyright law is equally important in determining the ownership of information and data (see the Copyright Designs and Patents Act 1988), together with the Copyright and Rights in Databases Regulations 1997 (SI1997/3032). The Companies Act 2006 has lead to a codification of various fiduciary duties, insofar as they apply to directors, and this will have an effect on the development of the law in this area over the next few years. In terms of court procedure, the most significant body of law is contained within the Civil Procedure Rules 1998 (SI 1998/3132) (known as the CPR ). These complex rules regulate all High Court and County Court proceedings in England and Wales, and are referred to in detail below. In addition matters relating to evidence are subject to further rules (the Civil Evidence Acts 1968 and 1995). There are also various statues governing the relationship between a UK employer and its employees. Whilst none of these deal specifically with the issue of restrictive covenants, a working knowledge of them is useful. These include the Equality Act 2010 that, from October 2010 will regulate anti-discrimination legislation in the United Kingdom (the Equality Act will repeal and consolidate existing anti-discrimination legislation, that will stay in force until October 2010), the Employment Rights Act 1996, that regulates various aspects of the employer-employee relationship, most specifically job security; the Health & Safety at Work etc. Act 1974; the National Minimum Wage Act 1998; and the Working Time Regulations 1998 (SI 1998/1833). 3) Applicable Statutes or Rules (Specific Industry or Profession) There are no specific industry or professional rules or statutes that have a direct bearing on the issue of restrictive covenants. B. Post-termination obligations Once the relationship terminates, the implied obligations become extremely weak. Therefore it is commonplace in UK for employers to seek to agree express post-termination restrictions with the employee. The restrictions tend to be more extensive in contracts for senior staff, and there may well be protracted negotiations with senior recruits as to the terms of the restrictions to be placed on them. Junior employees tend to be under less onerous restrictions, and normally find that the contract terms are offered on a take it or leave it basis by their prospective employer. Employers must take particular care when agreeing post-termination restrictions, given the suspicion of the judiciary towards them. The (rebuttable) presumption of the judiciary is that all post-termination restrictions are void as being a restraint of trade. The basis of the doctrine of restraint of trade is the protection of the public interest: At common law every member of the community is entitled to carry on any trade or business he chooses and in such manner as he thinks most desirable in his own interests, and no one can lawfully interfere with another in the free exercise of his 3

4 However: trade or business unless there exist some just cause or excuse for such interference. (Lord Parker of Waddington, Attorney-General of the Commonwealth of Australia v Adelaide Steamship Co. Ltd 1.) Restraints of trade and interference with individual liberty of action may be justified by the special circumstances of a particular case. It is a sufficient justification, and indeed it is the only justification, if the restraint is reasonable reasonable, that is, in reference to the interests of the parties concerned and reasonable in reference to the interests of the public, so framed, and so guarded as to afford adequate protection to the party in whose favour it is imposed, while at the same time it is in no way injurious to the public. 2 As such, an employer seeking to enforce a post-termination restriction must be able to demonstrate to the court that the particular restraint they want to enforce is reasonable: It must be designed to protect a legitimate business interest of the employer; drafted in no wider terms than are necessary to protect that interest; and not otherwise against the public interest, which is best served by allowing as much freedom to pursue one s trade, profession or calling, as possible. When considering whether the courts will enforce a restriction, UK lawyers commonly fall back on judicial precedent, assessing what the courts have held to be reasonable or unreasonable in previous cases. Advice to employers who are seeking to put in place restrictions, or seeking to enforce them, is therefore always qualified by reference to the wide discretion that a judge has to apply the law and then determine whether or not the restriction is valid or void. The most common types of post-termination restrictions are non-competition; nonsolicitation/dealing with customers; and non-solicitation of staff. Confidentiality obligations are also common. Occasionally an employer may seek to protect the disruption of the supply-chain by preventing the employee from dealing with suppliers. Restrictions are usually set out in the contract of employment that is agreed prior to or at the beginning of the employment relationship. However, restrictions are now routinely included in share option and other equity schemes. Sometimes the employer may seek to introduce new restrictions during the employment relationship. It is always advisable to consider refreshing them on commencement of a promotion or new role within the organisation, as the employee s original restrictions may have been prepared when the employee was in a much less commercially sensitive position. Restrictions may also be separately introduced by the employer at the behest of a client or customer or on legal advice, following reviews of the standard restrictions to employer uses. This is particularly common where the client or customer is sharing confidential information or research and development with the employer, and wants to ensure that the employer has adequate protection. 1 Attorney-General of the Commonwealth of Australia v Adelaide Steamship Co. Ltd [1913] AC Lord Macnaghten in Thorsten Nordenfelt v The Maxim Nordenfelt Guns and Ammunition Company, Limited [1894] AC 535 HL. 4

5 If restrictions are being introduced during the relationship then the employer must consider the issue of consideration. Any variation of a contract, or new contract entered into, must be accompanied by consideration. The payment being made to the employee for his agreement to the new restriction should be clearly documented. All types of post-termination restriction are regarded as a restraint of trade, and so void unless they are proved to be reasonable. This means that they must protect a legitimate interest of the employer, and go no further than is reasonable to protect that interest. In adjudicating on the enforceability of the restriction the court will expect the employer to identify the legitimate business interest. The interests most regularly cited by employers seeking to enforce restrictions are confidential information and goodwill and customer connection. However, other legitimate interests are also recognised by the courts, such as the stability of the workforce. Once the court is satisfied that the employer has an interest capable of protection, it will then consider whether the restriction is reasonable. It will consider: The length of time for which the restriction applies; The effect on the employee (how detrimental will the restriction prove to be to the employee in earning a living or pursuing his profession?); The commercial threat posed by that employee; Whether the commercial threat could be (or could have been) addressed by less draconian means; Whether the restriction has been successfully implemented. This will not usually be an issue if the restriction was entered into at the beginning of the employment relationship, but the courts will expect to see that any restriction introduced at a later date was effectively introduced, and in particular that there was consideration. Whilst the law is unclear on the point, employers should assume that the amount of consideration is relevant, and in particular should not seek to rely on minimal or peppercorn consideration. If a pay increase is being agreed at the same time that the restrictions are being varied then the employer should ensure that at least part of this is identified as being consideration for the new restriction. If the court finds that the restriction goes further than is reasonable then it will strike it down. It has no power to introduce less stringent provisions into the restriction, such as reducing the period for which the restriction will apply. Exceptionally it can sever, or bluepencil the restriction, removing the words of the restriction that make it unenforceable, so as to leave in its place an enforceable covenant. The test for severance requires that the wording that makes the provision unenforceable can be removed without any requirement to modify or add to the wording that remains. In addition, the wording that does remain must be sufficiently similar in character to the unaltered wording, to enable to court to conclude that it still reflects the agreement that the employer and employee entered into Non Compete restraints These are the most difficult form of restraint to enforce. Courts often find that a blanket ban on competition is unreasonable. However, in certain circumstances they will be upheld, most commonly to protect the employer s legitimate interests in maintaining the confidentiality of information. For example, in Thomas v Farr 4, the court accepted that the confidentiality restrictions in a service agreement for the Managing Director of a specialist insurance broker would be difficult to police, and the only way of effectively protecting this interest was to uphold a non-compete restraint. The same considerations applied in the 3 Sadler v Imperial Life Assurance Co of Canada Ltd [1988] IRLR 388) 4 Thomas v Farr [2007] IRLR 419 5

6 earlier case of Littlewoods v Harris 5 where a non-compete clause was upheld by the court because the defendant director had intimate knowledge of the employer s (who produced mail order catalogues) information relating to sales trends, percentage and identity of returns, sources of manufacture, business plans for the foreseeable future, their immediate plans for the next two seasons catalogues and the results of their market research. The courts will be prepared to uphold non-compete clauses where the employee is not in a senior position. In Norbrook Laboratories 6 the court was prepared to uphold a restriction agreed by a territory manager, paid 25,000 per year. Again, the legitimate interest of the employer was its confidential information: the employee had been privy to customer lists; the list of the most valuable customers; the discounts given to customers; the lowest price that could be quoted for each product; and the actual discounts given to each customer. She was also found to have had access to sales strategy and sales trends. It is obvious that if the courts are to protect information by enforcing a non-compete restriction then only highly confidential information will be protectable. Arguably, an employer can seek protection even if that information is not so highly confidential as to be a trade secret (see below), the courts will not grant protection where there is any doubt about confidentiality or its value to the employer. In Norbrook 7 the court was also prepared to find that the employer s customers were a protectable interest. The employer had built up personal professional connections with 270 of the employer s customers and targets within her territory. The court held that this was a particularly vulnerable interest at the time each year when purchasing arrangements were being renewed. The boundaries of a non-compete restraint need to be carefully drafted: what is meant by competitive activity, the geographical extent of the restriction and the time for which the restriction will apply will all be carefully scrutinised by the courts. Once the courts have identified that there is a legitimate interest capable of protection it will consider the other factors relevant to reasonableness. The duration of a restriction is always a critical factor. The court may consider this by reference to the length of time it takes to develop new products, (as in LTE Scientific Ltd 8 which concerned an application to enforce a twelve-month restriction against a former technical director, who entered into restrictions on the sale of his company to the claimant); or by reference to the sales cycle (12 months see Norbrook 9 above). However, 12 months is likely to be the maximum period of the restriction. Six months is more likely to be reasonable. The extent to which the restriction needs to take into account any prior period spent on garden leave also needs to be considered. In Credit Suisse Asset Management Ltd 10 the court held that a six month non-compete restriction following six months on garden leave was enforceable in this case, but that any period served on garden leave was a factor for the court 5 Littlewoods v Harris [1978] 1 ALL ER Norbrook Laboratories (GB) Limited v (1) Rebecca Adair & (2) Pfizer Limited [2008] EWHC 978 (QB) 7 Supra 8 LTE Scientific ltd v Thomas [2005] EWHC 7 9 Supra 10 Credit Suisse Asset Management Ltd v Armstrong & Others [1996] IRLR 450 6

7 to take into account when assessing reasonableness. It is now commonplace for the contract to express that a restriction will be reduced in duration by the length of time that the employee spends on garden leave. What is, and what is not, regarded as competitive activity must be properly defined if the restriction is to be valid. It should be expressly stated that the prohibition on competition only applies to activities similar to or in competition with the employer s business. The courts can be pedantic when considering the precise ambit of a restriction: in Routh v Jones 11 the court considered a restraint on a medical practitioner that sought to prevent the employee from practising in any department of medicine, surgery or midwifery within a 10 mile radius of its practice. The court refused to enforce the restriction on the grounds that it prevented the employee from being engaged as a consultant physician; a position that could not reasonably be perceived as presenting any threat to the employer. If it is difficult to define the precise nature of the activity that the employee should be prevented from doing then the fall-back is often to limit the restriction by reference to those activities in which the employee was materially involved during his employment. In Christie Owen & Davies plc v Walton 12 the court was prepared to interpret material involvement as being involvement in businesses or activities that amounted to a significant part of the employee s work. Occasional involvement in other areas of the employer s activities would not, therefore, be caught by the restriction. In terms of geography, courts will only uphold worldwide prohibitions (or a restriction that contains no reference to a geographical area) in those cases where the employer can demonstrate that they have a genuinely worldwide business, and the employee poses a threat to legitimate interests within that context. Such a restriction was upheld in Dyson Technology Limited v Strutt 13 the court holding that the restriction was reasonable to protect the employee using the employer s trade secrets and confidential information that the employee had acquired whilst working in the employer s research and development department. The one-year worldwide non-compete clause enabled protection of that highly confidential information. However, in most cases the geographical nature of the restriction must be much more circumscribed, and the courts will examine the employer s relevant market within the context of the employee s sphere of influence within that market. 2. Non Solicitation of Clients and Customers The same issues relating to restraint of trade and the protection of legitimate interests apply to non-solicitation clauses. In general, the courts are prepared to find that they are more reasonable ways for the employer to protect its business after termination than blanket non-compete provisions. This is because, in most cases, they will not prevent the employee from practising his trade or profession; instead they prevent the employee from dealing with an identifiable group of customers for a specified period of time. As such, non solicitation provisions are commonly used by employees. However, non-solicitation provisions are of limited value, given that it is often difficult for an employer to establish that its former employee has obtained business from a customer or client by having solicited them (as opposed to the customer having sought out where the employee has moved to and then approaching them). For this reason, non-solicitation clauses are usually combined with non- 11 Routh v Jones [1947] 1 All ER Christie Owen & Davies plc v Walton [2008]CSOH Dyson Technology Limited v Strutt [2005] EWHC

8 dealing clauses. These prevent an employee from providing goods or services to that customer or client. Therefore, even if the employer cannot establish that its former employee has solicited sought out the business of one of its customers, it can still demonstrate, merely by the act of providing goods or services to that customer, a breach of a restraint clause. Clearly restrictions are most effective, and most likely to be upheld where an individual employee can have relationships and therefore generate goodwill with individual customers. They are much less suited to organisations engaged in mass markets, or offering services to the public at large. For example, a recruitment consultant could not seek to prevent solicitation of any of its 6-7,000 clients, who were serviced out of its 34 nationwide branches 14. In most cases, particularly involving more junior employees, the restriction should be designed so as only to apply to clients or customers with whom the employee has had dealings, or those who have had access to confidential information. The most robust restrictions also recognise that employees may cease to have contact with/influence over customers during the course of their employment. Therefore it is good practice only to seek to restrict contact with customers where the employee has had contact with them in a defined period prior to the termination date. Usually the period of time prior to the termination date is the same as the restriction, and if it is too long then it will affect the enforceability of the restriction. (For an example where the period prior to termination was too long see the Norbrook 15 case above where the employer sought to apply it to the five-year period prior to termination). A restriction can also be drafted so as to prevent solicitation of or dealing with potential clients. This is useful where the employer invests heavily in trying to secure new business, and where the employee has a substantial involvement in that process. Such clauses should be drafted so that they capture post-termination solicitation of or dealings with potential clients as a realistic prospect, rather than an employer s wish-list of customers. If an employee brings business or personal connections with them then it is usual for the employee, when negotiating the terms of any restrictions to seek to carve out, or disapply those restrictions to those connections. This is ordinarily done by way of a schedule to the contract, listing those individuals or companies who the employee can solicit or deal with after termination. 3. Non Solicitation of Employees Contracts will often contain a separate provision prohibiting poaching of the employee s colleagues. Again, the employer must be able to demonstrate the existence of a legitimate interest. This may well be maintaining the stability of a workforce, particularly where the employees have gained knowledge of their colleagues qualifications, skills, rates of pay etc 16. Blanket restrictions will not be enforceable and they must be limited to a particular class of employee, 14 Office Angels v Rainer [1991] IRLR Supra 16 Dawnay, Day & Co Ltd v De Braconier D Alphen [1997] IRLR 442 8

9 either by reference to status (In Dawnay Day 17 a reference to senior managers was held to be acceptable), or by reference to their importance to the business, their expertise or their knowledge. Non-employment clauses are becoming increasingly used, particularly in financial services markets, where team-moves (where a competitor tries to recruit an entire team of employees from a rival, often by initially recruiting one or two senior members of that team and then seeking to use their knowledge, reputation and contacts to entice other employees to join) are common and employers are becoming increasingly adept at extracting employees from competitors without solicitation being detected. As with the non-dealing clauses referred to above, the mere fact of employment is proof that the restriction has been breached. It is currently unclear whether the courts will be prepared to enforce non-employment restrictions other than in exceptional cases. Team moves have also become the subject of springboard injunctions (see below). C. Confidentiality and Trade Secrets There are no statutes specifically concerned with employee s obligations of confidentiality and trade secrets. Instead, as with post-termination restraints, the law has developed through case law. In recent years this has been modified slightly by considerations of human rights, data protection and the growth of an individual right to privacy (see below). However, the principle remains that employers who want to ensure as much protection as possible of their confidential information must put in place well-drafted contractual restrictions. These confidentiality restrictions are included in contracts in addition to noncompete clauses, which are often introduced to protect an employers legitimate interest in protecting confidential information (see above). 1.Different Classes of information In the absence of expressly agreed restrictions, the obligations that exist during employment contrast starkly to those that exist once the relationship has terminated. During employment the employee s obligation to protect the employer s confidential information is part of the implied obligation of good faith and fidelity. However, this obligation of good faith and fidelity does not survive the termination of the employment relationship, and so cannot be relied upon to protect confidential information post-termination. Since the mid- 1980s the courts have classified information into three classes 18 :- Class 1: Trade secrets This is the most important type of information. It is highly confidential information that is extremely important to the employer s business.: A trade secret is information which, if disclosed, to a competitor, would be liable to cause real (or significant) harm to the owner of the secret Lansing Linde v Kerr 19 The information that falls into this category will vary from employer to employer. However, the court provided a useful guide in Thomas Marshall v Guinle 20 as to what 17 Supra 18 Faccenda Chicken Ltd v Fowler [1986] IRLR Lansing Linde v Kerr [1991] IRLR 80 9

10 information is potentially confidential. The list includes names and addresses of customers and suppliers; negotiated prices; details of current negotiations; and actual and proposed new product ranges. Class 2:Confidential information Information that the employer classifies as confidential, but which does not contain the obvious characteristics of confidentiality inherent in trade secrets. Often the courts will be highly influenced as to how the employer treats this kind of information. Does it mark it as confidential, for example? Is it kept secure, or is access only permitted to a limited number of employees? Class 3: Trivial information Information that is trivial, in the public domain, or which forms part of the general skill and knowledge of the employee. The courts are prepared to imply into the contract of employment an obligation on an employee not to disclose it use Class 1 or Class 2 information during employment. After employment has terminated, the only implied protection relates to Class 1 information. This protection is inadequate, and needs to be supplemented by express confidentiality undertakings. Usually these undertakings will seek to protect Class 1 and Class 2 information, both during employment relationship and after it has ended. Unlike other forms of post-termination restrictions the courts do not expect to see any time limit on the restriction the employee must keep the information confidential indefinitely, although quite clearly the prohibition on using or disclosing the information will cease. Express confidentiality agreements also seek to define what information the employer regards as confidential. This is important, as there is a great deal of judicial uncertainty as to where the dividing line lies between class 1 and class 2 information, and between class 2 and class 3 information. Lancashire Fires Ltd v SA Lyons & Co Ltd 21 stated: Ultimately the court must judge whether an ex-employee has illegitimately used the confidential information which forms part of the stock in trade of his former employer, or whether he has simply used his own professional expertise, gained in whole or in part during his former employment When deciding how to classify information the courts will be influenced by how the employer has treated that information. An employer will be in a far stronger position if it can show that it has identified the information as confidential, and then controlled access to it, and put in place security measures. It is also useful to provide a guide to employees as to how to protect and store confidential information. In addition to the obligations of confidentiality mentioned above, employers may also be able to rely upon database rights. The Copyright and Rights in Databases Regulations 1997 vests copyright in a database in the owner of that database. If an employee or ex-employee downloads, prints-off or extracts information from that database without permission then the employer s copyright is infringed, giving the employer rights to pursue the employee for compensation or an injunction. This can be important protection for an employer who has 20 Thomas Marshall v Guinle[1979] Ch Lancashire Fires Ltd v SA Lyons & Co Ltd [1997] IRLR

11 given access to client or customer databases to its employees. It is often difficult to prove the confidentiality in a database and the Regulations provide an effective alternative remedy. The Data Protection Act 1998 also needs to be considered. Much of an employer s confidential information may consist of personal data about customers or clients. It is held in electronic format then the employer will be a data user under the Data Protection Act. Data users are under a number of legal obligations designed to uphold the rights of individuals about whom data are held (known as data subjects). If a former employee continues to hold data belonging to the employer then that is likely to constitute a breach of the Data Protection Act by the employee. Pointing this out to the employee, and requiring the return of the data can be a valuable additional way of encouraging former employees to return to their former employer information they acquired during their employment. 2. Misappropriation, Theft and Misuse It is usual for employers to ensure that employees are contractually obliged to deliver up to their employers all property which is in their possession on demand or on the termination of their employment. It is, of course, good practice for employers to ensure that they have a inventory of all property issued to the employee, and to ensure, insofar as possible, that all property is security marked or otherwise identifiable as the employers. It is also important to ensure that there is no ambiguity of ownership of the property, as the courts will expect the claimant to be able to establish a right of ownership. In terms of criminal sanctions, an employee who has taken an employee s property may have committed an offence under the Theft Act Theft is defined as the dishonest appropriation of property belonging to another, with the intention of permanently depriving the other of it (S1(1)). It is punishable by fine, imprisonment or a range of communityrelated sanctions. Whether to investigate and/or prosecute are matters for the police and the Crown Prosecution Service. Therefore, save for reporting an employee to the police, a complaint of theft provides little direct remedy for the employer. The Theft Act, together with the Fraud Act 2006, contain a number of further offences that relate to dishonesty. A civil remedy also exists under the Torts (Interference with Goods) Act If a person deals with goods in a manner that is inconsistent with the owner s rights, and with the intention of denying the owner s rights or asserting a right inconsistent with them then they will have committed the tort of conversion. This gives the owner the right to seek the return of the goods, or compensation for loss or damage suffered as a result of their misappropriation. A range of remedies also exists to provide for the detention, preservation and inspection of goods (see below under Temporary and preliminary relief ). The Copyright and Rights in Database Regulations, and the Data Protection Act 1998, both referred to above, also provide rights and remedies for misuse of information (see above). 3. Doctrine of Inevitable Disclosure The UK does not recognise the doctrine of inevitable disclosure or have any equivalent. 11

12 4. Employer Monitoring and Employee Privacy Rights Monitoring of employees at work is now commonplace. Usually employers will be able to monitor traffic; telephone calls are often recorded, particularly in regulated industries, and CCTV is widely used in workplaces that are open to the public. Monitoring needs to be undertaken with a degree of caution and with due regard to an employee s right to privacy. The key requirements for lawful monitoring arise under the Data Protection Act The Information Commissioner has issued a code of practice for employers (the Employment Practices Code). Part 3 of the Code is entitled Monitoring at Work. In addition to the Code of Practice, specific requirements aimed at regulating interception of electronic communications (primarily s and telephone calls) are contained in the Regulation of Investigatory Powers Act 2000 and the Telecommunications (Lawful Business Practice) (Interception of Communications) Regulations Monitoring is regarded as intrusive and potentially a breach of an individual s human rights. Monitoring should only take place if the individual is aware that they are being, or could be, monitored. Employers usually dealt with this by having a policy that sets out that employees may be monitored, and the purposes for which they may be monitored. In addition, it is usual to seek the employee s consent to monitoring. Consent is usually obtained in the contract of employment, although the Information Commissioner has questioned whether such consent can be regarded as having been freely given. The Code suggests that, prior to commencing any specific monitoring or investigation exercise the employer prepares an impact assessment. This involves considering the purpose of the monitoring; identifying the adverse effects of monitoring for the employee; considering any alternatives to monitoring; ensuring that obligations associated with monitoring are taken into account; and then determining whether the monitoring is justified. A failure to monitor/intercept communications lawfully can lead to sanctions being imposed by the Information Commissioner, who has the ability to restrict an employer s ability to process information (fatal for most businesses) or to undertake criminal prosecutions. In addition, individuals can pursue a claim for compensation in the courts. Both, however, are relatively rare in the United Kingdom, and few employers find that the law prevents them from undertaking monitoring that they genuinely believe to be in the best interests of their business. However, given the highly charged atmosphere that can surround disputes relating to covenants and confidentiality, employers should ensure that they are monitoring within the law, so as to counter-claims of wrong-doing from the employee. 12

13 ll. EXISTENCE OF A DUTY OUTSIDE OF AN EXPRESS COVENANT A. Duty of Loyalty (During and Post Employment) During the employment relationship the employee is under a strong implied obligation of fidelity. This places a number of restrictions on an employee s activities. Unsurprisingly there is an obligation on every employee not to compete with his employer, either during his own time or out of working hours. An employee is entitled to make preparations during his employment to compete once his employment has terminated. Clearly any such preparations must be made in his own time, and in addition, must not harm his employer s business in any way. The line between preparing to compete and actually competing is often a difficult one to tread, although judgements have given some guidance (see for example Shepherds Investments Limited v Waters 22 ). Here the judge held that taking a decision to compete and discussing that with friends and family would not constitute competition, nor normally would instructing lawyers or other professionals to advise. Soliciting customers of the employer, however, clearly would. The courts have also held that soliciting fellow employees would also constitute a breach of the obligation of fidelity 23 in which a solicitor offered his secretary a job in a competing practice he intended to set up after termination of his employment, 10 days before the end of his employment (irrespective of the existence of post-termination restraints). The practical effect of the obligation of fidelity is that an employee is not in a position to compete whilst the employment relationship continues. It is usually buttressed by express obligations on an employee, so as to ensure the maximum protection possible. These usually extend to not requiring the employee to have any competing interests (including, for example, a minor shareholding in competition); prohibiting the employee from working for anyone else whilst the employment relationship is continuing (regardless of whether that alternative employment is competitive), and controlling carefully confidential information. Notice periods can also be used to ensure that the employee remains under these obligations for the appropriate amount of time once the employee has given notice of their intention to leave. A long notice period will mean that the employee remains under the obligation of fidelity for some time once the employer has learned of the employee s departure (although the length of notice must be balanced against the added cost associated with long notice periods). B. Fiduciary Duty (During and Post Employment) Senior employees and directors will be under fiduciary duties, which provide a degree of obligation towards the employer over and above the duty of fidelity. On 1 October 2007 and 1 October 2008 relevant parts of the Companies Act 2006 came into force, codifying directors duties for the first time. Prior to this, all fiduciary obligations were the product of judge-made law. These are considered further below. First, it is worthwhile considering who owes fiduciary duties and to whom. All directors of a company owe that company fiduciary duties. Directors are normally readily identifiable from the public information available about a company at Companies House. Individuals can also be de facto directors, who are directors of the company if treated 22 Shepherds Investments Limited v Waters. [2007] IRLR Sanders v Parry [1967] 2 All ER

14 as such, in spite of the fact that they have not been validly appointed or shadow directors. A shadow director is a person in accordance with whose directions or instructions the directors of a company are accustomed to act. All are regarded as being in a fiduciary position regarding a company. A shadow director may not owe a company the full range of fiduciary duties, as it depends upon the positions they hold and functions they have. Directors owe fiduciary duties, regardless of whether they are also employees of the company. There is a distinction between executive directors, who are employed by the company, and nonexecutive directors, who occupy a position on the board but do not have any day-to-day responsibility for the operational management of the company. Many employees who are employed in senior positions will also owe fiduciary obligations. Whether a senior employee is in a fiduciary relationship is a question of fact in any particular case, but in principle the court will look at the status and autonomy of an employee, and how much trust the employer has placed in them. The over-riding factor is the extent to which the employer has either expressly or impliedly entrusted them to deal with its property. A clinical embryologist at Nottingham University s infertility clinic, who had responsibility for the overall operation and well being of the clinic, was held to be a fiduciary 24. It is also common for senior members of sales teams to be regarded as in a fiduciary relationship, regardless of whether they are also directors. The most relevant statutory fiduciary duties that are now found in the Companies Act 2006 are: - the duty to promote the success of the company ( s172); the duty to avoid conflicts of interest ( s175); the duty not to accept benefits from third parties ( s176); and the duty to declare any interest in a proposed transaction or arrangement with the company ( s177). These are to be interpreted and applied in the same way as the common law duties, and therefore the substantial body of law that pre-dates the Companies Act remains relevant. a) Duty to promote the success of the company. This replaces the common law duty to act in good faith in the best interests of the company. Its relevance to competitive behaviour is that it has been interpreted as placing a fiduciary under an obligation to disclose their own misconduct 25. An employee is not under the same obligation of disclosure. b) Duty to avoid conflicting interests and duties. A director must not place himself in a position where there is a conflict or possible conflict between the interests of the company and his own interests, or of other duties he owes to a third party. This applies particularly to the exploitation of an opportunity or information, and regardless of whether the company itself can take advantage of the opportunity. 24 University of Nottingham v Fishel [2000] ICR Item Software (UK) Limited v Fassishi [2004] IRLR 928) 14

15 Closely aligned to the prohibition on conflicts of interest is the prohibition on directors profiting personally from their relationship with the company. Again the duty applies irrespective of whether the company could have or would have been able to benefit from the opportunity themselves. The director is under an obligation to account to the company for any profit that he makes. c) Duty to declare an interest in any proposed transaction. A director must declare to the other directors the nature and extent of any interest in any proposed transaction or arrangement that the company may make. d) Duty not to accept benefits from third parties. A director must not accept any benefit from a third party which is conferred as a result of him being a director. The only exception is where the benefit cannot reasonably be regarded as likely to give rise to a conflict of interest. In many cases the breach of duty by a director can be forgiven if the company s board resolves to do so. 2) Fiduciary obligations on termination Fiduciary relationships end on the termination of the relationship with the company. As with other employees, a fiduciary relationship does not prevent the individual from preparing to compete. However, a fiduciary will be prevented from taking advantage of a maturing business opportunity, where his resignation is prompted by a wish to benefit from that opportunity himself rather than obtain that benefit for the company. A maturing business opportunity arises if there is a specific identifiable business opportunity from which the company could benefit. 15

16 III. LEAVE AND NOTICE REQUIREMENTS A. Rules on Garden or similar leave (and breach by the employer) An employee who wishes to leave to join a competitor may sometimes seek to leave employment without giving any, or any proper, notice. The written terms of the contract of employment or statement of main terms and conditions of employment should include details of the notice which the employee is obliged to give and entitled to receive. 26 Section 86 of the Employment Rights Act 1996 prescribes minimum periods of notice. The statutory minimum period of notice to be given by an employee who has been continuously employed for one month or more is one week 27. The contractual period of notice to be given will often be longer, especially in the case of senior employees. The statutory minimum period of notice to be given by the employer is one week where the employee has been continuously employed for one month or more, but less than two years. This rises so that the obligation is to give one week s notice for each complete and continuous year of employment up to a maximum of 12 weeks notice for 12 or more such years 28. Again, the contractual period of notice will usually be longer than the statutory period of notice where senior employees are involved. Where no notice has been expressly agreed, the common law will imply a reasonable period of notice. In determining what is reasonable a Court or Employment Tribunal would have regard to all the facts of the particular case, including the employee s length of service, their level of seniority and the length of any notice agreed with comparators or with other employees at a more junior or senior level than them. The period of notice determined upon will not be less than the statutory minimum period, however. Sometimes, recognising the commercial risk if the employee remains in active employment, employers will wish to put the employee on garden leave. By doing so, the employee s access to the employer s secret or confidential information and/or customer base will be cut off but, as the employment relationship continues, the employee will continue to be subject to his implied duty of fidelity. This will preclude him from engaging in competitive activity while the relationship continues. As a quid pro quo, for as long as the employment relationship continues, the employer will be obliged to continue to pay the employee his salary and to provide him with all contractual benefits. If he fails to do so, the employee will be able to bring a breach of contract claim or (subject to certain limitations) a claim for unlawful deductions from wages 29. Depending on the amount claimed, a breach of contract claim may be brought in the High Court or County Court or (providing that the claim arose or was outstanding at the time of termination of employment) in the Employment Tribunal. A claim for unlawful deductions from wages can only be brought in the Employment Tribunal. A failure to pay salary and to provide contractual benefits is also likely to amount to a fundamental or repudiatory breach of contract by the employer. The effects of this are discussed below. The ability to impose garden leave will often depend on whether the contract of employment contains an express provision permitting this. Even if it does, there is the 26 Section 1(4) (e) of the Employment Rights Act Section 86(2) of the Employment Rights Act Section 86(1) of the Employment Rights Act Section 13 and following of the Employment Rights Act

17 possibility that a Court might only be prepared to uphold the clause to the extent that it is reasonable in its ambit and/or in the way in which the employer seeks to enforce it (per Lord Justice Morritt in the Court of Appeal decision in William Hill Organisation Limited v Tucker 30, the Courts should not enforce a garden leave clause to any greater extent than would be covered by a justifiable covenant in restraint of trade ). Problems can arise if the contract of employment contains no express garden leave provision. Whether, in such a situation, an employer will be able legitimately to impose garden leave will depend on whether the employee has a right to work. Historically, English case law only recognised very limited categories of employee or worker as having a right to work, these being performing artistes and those whose pay is dependent on their productivity (e.g. piece workers). Everyone else had a different right, that being the right to be paid in return for being available to work. In general, to impose garden leave on an employee who has a right to work, but who is not subject to an express garden leave restriction, will amount to a repudiatory breach of contract by the employer. It should be noted that if the employee leaves in acceptance of that breach it would release the employee from all continuing obligations under the contract of employment in general. This includes express and implied obligations of secrecy and confidentiality, other express post termination restrictions, express obligations of co-operation, etc in relation to intellectual property rights, and so on. Thus, the employer will lose any hold it might otherwise have had over the employee s future competitive activities. The acceptance by the employee of the employer s repudiatory breach will also amount to a constructive dismissal. This, in turn, may enable the employee to make breach of contract and/or unfair dismissal claims against the employer (sections 94 and following of the Employment Rights Act 1996 deal with the right not to be unfairly dismissed). However, such claims can be hypothetical or secondary issues if, as is often the case, the employee can start work with a competitor immediately and if that work is at least at the same level of pay and benefits as the employee enjoyed with the original employer. In recent years the Courts have shown a willingness to extend the right to work to wider categories of employees/workers. The modern approach can be traced back to Provident Financial Group plc v Hayward 31 in which it was held that the right to work applied equally to skilled workmen and even to chartered accountants. Skilled workmen is a very broad label. Potentially it could include, at one end of the spectrum, skilled production workers who are recognised as such in their factory environment, through to salespersons (who need to be seen in the market place) or scientists (who need to continue to practise their art ). In William Hill Organisation Limited v Tucker 32 the Court of Appeal held, in essence, that a power to put on garden leave will not be implied if the employee has a right to work, as opposed to a right to be paid in return for being available for work. The case, which involved a senior dealer in a spread betting organisation, extended the right to work to those senior employees whose posts are specific and unique or whose skills require frequent exercise. There was no express garden leave provision in the employee s Contract of Employment. The 30 William Hill Organisation Limited v Tucker [1998] IRLR Provident Financial Group plc v Hayward [1989] ICR Supra 17