Art of the covenant

A recent case from the manufacturing sector (D Forshaw v Archcraft) serves as an important reminder to agree appropriate restrictive covenants at an early stage. The term ‘restrictive covenant’ is usually taken to mean restrictions in an employment contract (normally with a senior employee) that prevent unfair competition after employment ends.

The case of Forshaw shows that if employers fail to agree adequate covenants while relationships are good, they are likely to have problems imposing them later.

Problems at Archcraft

Archcraft manufactured component parts for windows and conservatories. It was a small company that faced an imminent threat to its business from employees who appeared intent on defecting to a rival.

The production and sales directors at Archcraft had already left the company to set up a competitor. Archcraft was understandably alarmed by statements from these former directors that they would “attack” Archcraft’s customers and staff, that they “owned” those customers and staff, and that the new company intended to harm Archcraft’s business.

Worse still, the new company attempted to recruit three more staff (the claimants in the Forshaw case) from Archcraft. All three had close connections to the new firm, being the two sons of the former production director, and his son-in-law. Unfortunately for Archcraft, none of them had restrictive covenants in their contracts.

Faced with the loss of key employees, confidential information and its customer base, Archcraft decided to bring the issue to a head. It asked the claimants to agree to restrictive covenants preventing competition for 12 months after employment. When the claimants refused, and to avoid any more damage to the company, Archcraft sacked them. The question was: were the dismissals fair?

Easing restrictions

The courts recognise that individuals have a right to earn a living and will only enforce restrictive covenants to the extent that they protect a “legitimate interest” of the employer. Clauses that go further will be void.

Employers cannot prevent competition through a blanket restriction (Atford v Lamont [1920]). It was exactly this sort of blanket restriction that Archcraft attempted to use in this case.

Initially, the tribunal that heard the claimants’ complaints of unfair dismissal found that those dismissals had been fair. They took account of the difficulties that Archcraft had. It was a very small manufacturing company. The three claimants were part of a team of 12 with specialist skills that were badly needed by Archcraft. The managing director was very concerned that the claimants would continue to gather confidential information for use in competition with the company. There was therefore a clear and immediate danger to Archcraft’s entire business.

The tribunal found that “it was reasonable of [the managing director] to feel that he had to make a decision on the evidence available to him”. The tribunal therefore found that he was reasonably entitled to decide that the claimants’ employment in the firm was not in its best interests. It held the decision to dismiss was fair.

This decision was overturned on appeal by the Employment Appeals Tribunal. While, in appropriate circumstances, employees who refuse to agree to reasonable restrictive covenants in their contracts could be fairly dismissed, the key question, however, was what impact did the attempt to impose unfair restrictions on employees have?

The Employment Appeals Tribunal said that “the question answered itself”. As a matter of logic, an employer who tries to impose unfair restrictive covenants on employees cannot fairly dismiss employees who then refuse to agree to them.

Future shock

Whilst the Forshaw decision is logical, it could place employers in a difficult position. This is because the scope of an employer’s “legitimate interest” is often uncertain until decided by a court.

As a rule of thumb, restrictive covenants cannot normally be imposed for a period of over 12 months. They should usually be confined to a relevant geographical area and industry. They shouldn’t restrict competitive activities unless absolutely necessary. A court is likely to regard a clause purporting to prevent the ex-employee from working for a competitor as unenforceable if the former employer’s business could be adequately protected by a clause preventing the solicitation of customers.

In the Forshaw case, a more modest clause, agreed with the claimants early on, could have sought to prohibit them from soliciting former clients in the same area and industry for six months. When problems then arose, Archcraft could have negotiated from a position of strength knowing that, even if the claimants disagreed that the restrictions were enforceable, they would not be keen to risk the costs of an injunction and a claim for damages if found in breach of their contracts.

By contrast, the “sign or dismiss” approach is much riskier. If a court disagrees that the restrictions that an employer tries to impose at a later stage were reasonable, any dismissal will be unfair.