When Teams Resign: Why Restrictive Covenants May Be Unenforceable for Private Equity Sponsors

From evidence to enforcement

In our last three posts, we addressed some of the key considerations in cases of actual or suspected coordinated employee departures, namely: the importance of immediate IT lockdowns and protecting client relationships (post 1), the conduct of forensic investigations to gather evidence (post 2), and navigating confidentiality and data protection obligations to avoid creating problems while investigating breaches (post 3).

In this post, we move on to consider a scenario where the employer has gathered compelling evidence that multiple senior employees coordinated their departures to join a competitor in breach of their post-termination restrictions. The employer is ready and willing to seek an injunction against the departing employees to prevent further client solicitation and to enforce the non-compete provisions. However, the employer then discovers that one leaver has a six-month non-compete, another has three months, and a third has twelve months — for essentially identical roles. In such a case, the employer’s claim to enforce its restrictions will be exponentially harder, and potentially unwinnable. This post explains why. 

The Utilitywise problem

In Utilitywise Plc v Northern Gas and Power Ltd [2017] EWHC 2520 (QB), the High Court refused an interim injunction to enforce restrictive covenants where employees of similar seniority had restrictions of inconsistent duration. The employer could not credibly argue that six-month restrictions were necessary and proportionate for some employees when it had accepted three-month restrictions for others in similar roles.

This is a common problem in businesses where employment contracts may have been updated over time, or where businesses were acquired with legacy employees on different terms. From an operational standpoint, these inconsistencies are understandable. However, from an enforcement standpoint, they may have serious consequences.

The interim relief challenge

In team move cases, interim injunctive relief may be the employer’s only meaningful remedy. That is because of the obvious point that by the time a case reaches trial, the restricted periods will have expired, and the commercial damage will have been done. But as a corollary, when restrictions are of short duration, courts apply a higher evidential threshold. Instead of merely showing that there is a “serious issue to be tried,” the applicant must demonstrate that it would likely succeed at trial. This is because where a restriction is of short duration, if an injunction is made, it is likely in practice to operate as a final determination of the dispute.

If restrictions are inconsistent across a team, respondents will argue that the longer restrictions are unreasonable restraints of trade, because the existence of shorter restrictions for employees with an equivalent role demonstrates that the longer restriction is not reasonably necessary to protect the employer’s legitimate proprietary interest. The burden will then shift to the employer to justify why the enforcement target needs a longer restriction than their colleague. The employer will usually struggle to make the argument credibly against the background of its own contracting history.

The gardening leave complication

Many employment contracts allow the employer to reduce post-termination restriction periods by reference to time spent on garden leave. This gives useful flexibility, but creates ambiguity about when restricted periods actually begin. In particular, should the date be deemed to commence on the garden leave start date, or alternatively on the termination date?

If the employment contract doesn't explicitly state when the "Restricted Period" begins, employers should expect arguments that it starts from garden leave (reducing its effective duration), or that garden leave time should be deducted from the restriction period. These ambiguities may undermine the employer’s ability to seek interim relief. 

The importance of preventative contract management

The most effective strategy is preventative. Sponsors should ensure that their portfolio companies take the following steps:

In our next and final post of this series, we will draw the threads together, by considering how to apply commercial pressure to the departing employees appropriately to achieve an effective resolution, and when seeking court remedies makes strategic sense.