Restrictive Covenants

What a court will usually NOT do

Certain powers cannot be exercised by the court if breach found to exist: - 1. Cannot substitute reasonable covenant. • Empire Meat Co. v Patrick [1939] 2 All ER 85. - 2. Cannot alter terms of the covenant. • Mulvein v Murray 1908 SC 528. • Lux Traffic Controls Ltd v Healey 1994 SLT 1153. • Prophet plc v Huggett [2014] EWCA Civ 1013. • ... Unless a particular interpretation of restrictive terms reflects the true intention of both parties. • However, if covenant split into different obligations, if not interrelated, and can be separated, courts will do this to uphold one part and refuse to enforce another: - Mulvein v Murray 1908 SC 528. • Also see: H. L. MacQueen, "Restrictive covenants (Scotland)" J.B.L. 1990, Jul 341-345.

Trade secrets and Confidential Information.

In considering whether information was a trade secret or the equivalent of a trade secret, the court should have regard to: (a) The nature of the employment and the status of the employee. (b) The nature of the information. (c) Whether the employer had stressed the confidentiality of the information to the employee. (d) Whether the information could be isolated from other non-confidential information.

Trade secrets and Confidential Information Case: Faccenda Chicken Ltd v Fowler [1986] 1 All E.R. 617.

- Faccenda Chicken Ltd had employed Fowler as sales manager. -The contract of employment made no provision restricting use of confidential information. -Fowler left to set up in competition. T -he company now sought to prevent him using confidential information for this purpose. The Court held that the information and the advantage flowing from it was obtained through dishonesty.

Stewart v Stewart (1899) 1 F 1158

- Feud between two brothers. -One brother employed the other as a photography assistant in Elgin. Working as a two man business. -The brother who was the photography assistant required a loan and said that he would not work for any other photography business with a 20 mile radius of Elgin. -He then wanted to move away and run his own business, in Elgin itself. -The Court upheld this Restrictive Covenant as reasonable - it is questionable if that would be the verdict of the Court today.

Sale of a Business

- Inserted in order to protect 'goodwill' value of the business. -'Goodwill' comprises the value of the business attributed to the reputation and customers of the business. -Usually will require the seller to refrain from opening or operating a business within a certain area for a certain time. -Bargaining power of the parties? -Purchaser can enforce Restrictive Covenant against seller but not the other way around.

Influence over Existing Customers Case : Scottish Farmers Dairy Co v McGhee 1933 SC 148.

- McGhee the Milkman had a good relationship with the customers of Scottish Farmers Dairy Co and was the face they recognised when they received their milk. -Customers liked the service they were getting and if the Milkman McGhee left for another company, it was likely they would all switch to that company instead.

Restrictive Covenants

- Restrictive covenants (covenants in restraint of trade). -Terms that restrict the movement of employees post employment and the employer has a concern that the employee may take information to a competitor so put restrictive terms on the contract to try and prohibit this. -E.g. prohibitive terms in employment contracts, or in contracts for the sale of a business. -Problems with enforcement if specific contract terms are too wide in scope.

Certain Variables are Key

- Scope of business concern. -Scope of activity of individual. -Strength of customer influence.

Width of the Restriction

- Test of "reasonableness". -"An agreement not to exercise a particular trade or profession may be a pactum illicitum if it imposes a restriction wider than is reasonably necessary to safeguard the interest it is designed to protect." - Gloag. -In all three types of Restrictive Covenants (spatial area over which restriction is to operate; duration in time for which restriction is to operate; nature of restriction imposed), the clause will only be valid if it is not too wide in either of the variables commonly used: time and space. If it is, it will be unenforceable. -In considering this, the facts of each case will be looked at individually.

Prophet plc v Huggett [2014] EWCA Civ 1013.

- The High Court Judge had the audacity to add words to a term that did not make much sense to in relation to the dispute. -The Court of Appeal came down on the High Court Judge and overruled his decision. -So, the Court will interpret terms but they should not rewrite them.

Contract Term Deemed Unenforceable

- The most common is a contractual term, restricting someone from working: these will be legal but only if reasonable and in public interest. - Most commonly used with employees who are restricted from working in certain circumstances after leaving the employer. -Can be temporal, geographical, subject-based or a mixture. -The courts in considering the legality of such a clause are balancing the tension between freedom to contract and freedom to trade/work for a living. -Reasonableness is judged objectively by the courts, not viewed from the parties' subjective positions. -"An agreement not to exercise a particular trade or profession may be a pactum illicitum if it imposes a restriction wider than is reasonably necessary to safeguard the interest it is designed to protect." -Gloag. -patucm illicitum - an unlawful agreement or one contrary to public policy.

Influence over Existing Customers

- When an employee has an influence over existing customers.

Trade secrets and confidential information Case : Bluebell Apparel v Dickinson 1980 SLT 157.

-Dickinson worked as a trainee manager for a company called Wrangler Denims near Falkirk. -He had agreed not to disclose any trade secrets or work for any other competing business for two years. -The Restrictive Covenant also prevented him from working pretty much anywhere else geographically! -Dickinson would find it difficult to find a living due to the extremely restricted geographical range that he could work in (basically nowhere) and for the period of two years being quite long. -Dickinson wanted to leave Wrangler Denims and work for Levi Strauss & Co instead. -The Court held that because even at Trainee Manager level, Dickinson had had access to important information regarding to the business and the Restrictive Covenant should stand!

What is taken into consideration by courts?

-Difficult to predict outcome of disputes due to the specific facts, and low-level court/tribunal decisions, especially if the restriction is contained in an employment contract. Courts/Tribunals take a holistic approach: -Nature of the business. -Area from which customers come. -Position held by employee; responsibilities, access to what type of information. -Length of time during which he would be able to harm his employer's interests.

Poaching of Clients Case: Fitch v Dewes [1921] AC 158.

-Fitch worked as a Solicitor's Clerk in Tamworth, England. -He had agreed not to work within 7 miles of that town, as Tamworth was not a big town. - Fitch was in a position to entice/poach customers away.

The restriction must not be excessive, given its aim Case : Schroeder Music Publishing Co Ltd v Macaulay 1974 1 WLR 1308.

-Macaulay, a novice songwriter aged 21, entered a standard form agreement with Schroeder Music, whereby they would have the exclusive benefit of his compositions. -The global copyright was assigned to another party in return for a fixed percentage of any royalties. This was to last five years and could be automatically extended for five years if the royalties went above £5000. -Schroeder Music could terminate or assign the contract, but Macaulay could not, and Schroeder was under no obligation to publish or promote anything. Macaulay claimed the agreement was contrary to public policy. -The House of Lords held the standard form agreement that could not be justified as moulded under the pressures of negotiation, competition and public opinion. -Macaulay had no bargaining power. The defendants purported to be able to arbitrarily decline to exploit the pursuer's work in which event the pursuer's remuneration under the agreement would be limited to a £50 advance payable thereunder during the five-year period. -The defendants' power to assign precluded the argument that the restrictions would not be enforced oppressively. The defendants had failed to justify restrictions which appeared unnecessary and capable of oppressive enforcement.

Examples of Cases

-Mason v Provident Clothing Co Ltd 1913 AC 724. -Stewart v Stewart (1899) 1 F 1158. -A & D Bedrooms Ltd v Michael 1984 SLT 297. -International Computers Ltd v Eccleson 2000 G.W.D. 28-1074.

Mason v Provident Clothing Co Ltd 1913 AC 724.

-Mason was employed as a canvasser by Provident Clothing Co Ltd. -A restrictive covenant in the employment contract provided that the appellant could not, within three years of the termination of his employment, be employed by "any person, firm, or company carrying on or engaged in a business the same as or similar to that of the [respondent], or assist any person employed or assisting in any such business, within twenty-five miles of London aforesaid where the company carry on business." -The County Court judge had granted an injunction in favour of Provident Clothing Co to prevent the Mason from breaching this restrictive covenant. T -This was reversed by the Divisional Court on the basis that the relevant clause in the contract was too vague to be capable of being enforced by injunction. -The Court of Appeal reinstated the order of the County Court. -On appeal to the House of Lords, Mason submitted, inter alia, that the agreement between the parties was an unreasonable restraint on trade and, upon any construction the agreement of a radius of twenty-five miles is wider than what was reasonably required for the protection of Provident Clothing Co Ltd. -Viscount Haldane L.C. held that the respondents had failed to show that the restriction went no further than was reasonable for the protection of their business. -Notably, there was no evidence that a canvasser, such as Mason, was likely to have come into possession of any special knowledge of the respondent's business which would be recognised as a trade secret. -Accordingly, the respondents had bound the appellant in a manner which might only have been necessary if they were carrying on a business of a different kind.

It protects a legitimate business interest; merely preventing lawful competition IS NOT a legitimate business interest Case: Office Angels v Rainer-Thomas [1991] I.R.L.R. 214.

-Office Angels were an Employment Agency where the Manager, Rainer-Thomas was wanting to leave and move to work for a Competitor. - The Restrictive Covenant in this case was after leaving the business, for a period of 6 months, Rainer-Thomas could not work within 1 KM of the Office Angels workplace or deal with any of it's customers. -Office Angels were wanting to prevent Rainer-Thomas from from leaving. -After the termination of their employment, Rainer-Thomas commenced work at another agency within the restricted radius and there was evidence that they had dealings with Office Angel's customers. -The High Court judge held that Office Angels had a right to protect their goodwill but that the restriction against all of their customers was too wide and therefore refused to order an injunction enforcing the non-dealing covenant. --He further held that the covenant restricting Rainer-Thomas from working within a 1,000-metre radius of their former office was reasonable and therefore granted an injunction enforcing this restriction. -The Court held, allowing Rainer-Thoma's appeal and discharging the injunctions, that the judge had erred in finding that the clause restricting Rainer-Thomas from engaging in business was reasonable. The Restrictive Covenant was deemed unreasonable.

Trade secrets and confidential information Case : Malden Timber Ltd v Leitch 1992 SLT 757.

-Restrictive Covenant contained a very broad term that due to the confidential nature of the business, the employee would be extremely restricted with information that he could give. -The Court held that the Restrictive Covenant was too broad as to what information was classified as confidential. -There needed to be more for the Court to work with before they uphold a term like this.

Restrictive Covenants Conclusion

-Restrictive covenants are per se illegal, unless they are objectively reasonable, protect legitimate business interests and are not contrary to Public policy.

Partnership Contracts Case: Dallas MacMillan and Sinclair v Simpson 1989 SLT 454.

-Solicitors in Glasgow sought to stop a partner leaving and taking a partnership in another firm. The Restrictive Covenant states that any partner is not entitled to work as a solicitor for anyone other than the firm within 20 miles. -Simpson was wanting to take up employment of another firm. -The court held that the clause was unreasonable in protecting the firm's interests as it prevented Simpson from working as a solicitor, not only a partner and the distance went beyond what was necessary to protect the firm.

Partnership Contracts

-The Partners in a business are regarded as equal. -Here, the interest sought to be protected is similar to those in an employment Restrictive Covenant. -However, the courts are more welcoming of Restrictive Covenant here, since more equal bargaining position. - Usually affects professional persons.

Poaching of Clients

-The fear that the employee shall leave and take customers with him/her.

Scope of Business Concern

-The public have an interest in every person's carrying on his trade freely; so has the individual. -All interference with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy, and therefore void. -That is the general rule...It is sufficient justification, and indeed it is the only justification, if the restriction is reasonable- reasonable that is, 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." per Lord MacNaghten.

General principles - (il)legality of restrictive covenants

1. The starting point is that restrictive covenants are void and unenforceable: the party relying on them will have to persuade the court of their legality and that they are reasonable in the contract. 2. It may be more straightforward to defend and rely upon an restrictive covenant in a sale of business contract or partnership contract than in an employment contract. 3. A Restrictive Covenant will only be valid if: (i) It protects a legitimate business interest; merely preventing lawful competition IS NOT a legitimate business interest. -Office Angels v Rainer-Thomas [1991] I.R.L.R. 214. - (ii) Reasonable between the parties (objectively judged). -(iii) In the public interest. -George Walker & Co v Jann 1991 SLT 771. 4. The restriction must not be excessive, given its aim. -Schroeder Music Publishing Co Ltd v MacAulay 1974 1 WLR 1308

Remedies

There are three possible remedies for breach of a Restrictive Covenant clause: 1. Interdict (court order to stop activity) - where the 'balance of convenience' favours the pursuer, the proposed breach can be prevented from occurring. 2. Damages - to recover compensation for loss caused by breach - often combined with interdict in same action. 3. Intellectual property remedies - not based on Restrictive Covenant but on copyright, patent (invention) or trademark infringements - dealt with under statute, but can obtain interdict also.

Contracts of Employment

Three possible employers' interests might be sought to be protected in such a clause: 1. Trade secrets and confidential information. 2. Poaching of clients. 3. Influence over existing customers.