Case update
Enforceability of post-termination restrictions
The High Court has considered the enforceability of post-termination restrictions against a departing adviser. Notably, the High Court held that:
1. a post-termination ‘no dealing’ restrictive covenant was unreasonable and therefore not enforceable (as it was too long and there were already enforceable non-solicitation restrictions); and
2. companies within the wider group could not enforce the restrictions even though they had the benefit of a third party rights clause in the contract (as this is not effective in bringing claims against employees and workers).
Background
In AFH Independent Financial Services Ltd and another v Baker, Ms Baker, initially employed as a tax adviser and trainee financial adviser at a firm acquired by AFH Independent Financial Services Limited (AFH), became a self-employed adviser at AFH and entered into agreements containing restrictive covenants. These covenants were drafted to benefit both AFH and its other group companies. Upon her departure to join a competitor, AFH and its parent company sought to enforce these restrictions, alleging that Ms Baker had breached them by soliciting and dealing with former clients.
We summarise practical takeaways for employers below.
The decision
Enforceability of the restrictive covenants - overview
The Court upheld the enforceability of a 12-month non-solicitation covenant which prevented Ms Baker from soliciting clients with whom she had significant dealings during the previous 12 months. In the context of financial advice, where advisers commonly maintain client relationships through annual review cycles, the imposition of post-termination restrictions was reasonable and the non-solicit restriction itself was found to be reasonable.
By contrast, the Court held the 12-month non-dealing covenant to be unenforceable. That covenant would have prevented Ms Baker from dealing with former clients even where they approached her independently. The Court considered that it went further than reasonably necessary, particularly because the non-solicitation covenant already provided protection against active approaches to clients. A non-dealing covenant is particularly onerous and the Court held that AFH did not sufficiently justify why such a restriction on dealing with, as well as soliciting, clients is necessary, nor why a 12 month restriction was reasonable as opposed to, for example, 6 months.
Enforcement by group companies
Ms Baker’s contracts with AFH expressly stated that the covenants were for the benefit of AFH and all its group companies. They also included a third-party rights clause purporting to allow group companies to enforce the covenants to the fullest extent permitted by law.
However, the Court held that this wording did not allow AFH group companies to enforce the restrictions automatically. Section 6(3) of the Contracts (Rights of Third Parties) Act 1999 provides that third parties have no right to enforce "(a) any term of a contract of employment against an employee (b) any term of a worker's contract against a worker (including a home worker), or (c) any term of a relevant contract against any agency worker". As Ms Baker was held to be a worker (see the “Worker status” section below), other AFH group companies could not rely on the third-party rights provisions to enforce the covenants against her.
Section 6(3) therefore prevents third-party group companies from enforcing employment and workers contracts against the employees and workers (including self-employed consultants if they qualify as a worker) of the contracting company.
Attempts by AFH to rely on a 'trust of a promise' to circumvent this statutory restriction were rejected. The Court emphasised that neither party could identify any authority in which a trust of a promise had been used to enforce restrictive covenants and further found no intention to create a trust. Only the direct contracting entity (here, AFH) could enforce the covenants.
Worker status
Despite being described as self-employed, Ms Baker was held to have 'worker' status following the principles established in Pimlico Plumbers Ltd v Smith. Pimlico established that an individual (including someone labelled as an independent contractor) is a ‘worker’ within section 230(3) of the Employment Rights Act 1996 if they are obliged to perform work personally and the company that the work is performed for is not genuinely a client or customer of an independent business. Ms Baker’s classification as a ‘worker’ limited the ability of the AFH group companies to enforce the covenants due to Section 6(3) of the Contracts (Rights of Third Parties) Act 1999, as set out in the “Enforcement by group companies” section above.
What constitutes solicitation?
The Court held that merely informing clients of a departure does not amount to solicitation. Likewise, where a client independently decides to follow an adviser, subsequent contact to facilitate the move will not necessarily constitute solicitation.23-24 However, conduct that encourages clients to move or responding to expressions of interest in a manner calculated to obtain their business may more likely constitute solicitation – there needs to be an active component and a positive intention.
On the facts, AFH explicitly told Ms Baker to tell clients she was leaving AFH after she had handed her notice in. The Court held that this did not constitute solicitation. This made it difficult for AFH to prove that solicitation had taken place in respect of many of the clients that departed to her new company.
The Court did, however, find that Ms Baker had solicited clients where she asked her solicitor to tell them that she was moving to a firm more aligned with her values and suggest that they contact her to discuss this further. The Court found Ms Baker solicited three clients on this basis, in breach of the non-solicitation covenant.
Additionally, the Court confirmed that "suspicion" of solicitation was not sufficient and there must be evidence that each client who left was solicited.
Practical implications for employers
Review contracting structures
Ensure that the company requiring protection is the direct contracting party with the individual (where the individual is an employee or worker, as third-party rights clauses are unlikely to be effective in respect of workers and employees).
If multiple group companies need protection, businesses should consider entering into separate agreements with the individual.
Tailor restrictive covenants to the role and relationship
Avoid using standard or boilerplate covenants. Draft restrictions that are specific to the individual's status (employee, worker, or genuinely self-employed) and the nature of their client relationships. Covenants are more likely to be enforceable if necessary for a legitimate business need.
Limit the scope and duration of covenants
Non-solicitation covenants are more likely to be upheld if they are reasonable in scope and duration (e.g. 12 months where there is an annual client contact cycle).
Non-dealing covenants are less likely to be enforceable, especially if a non-solicitation covenant is already in place.
If both are used, consider making the non-dealing covenant shorter than the non-solicitation covenant and ensure that they are drafted as separate clauses/sub-clauses so that if one is unenforceable, the other remains effective.
Consider garden leave
Placing departing employees or workers on garden leave may help protect client relationships and reduce the risk of solicitation.
Gather evidence of solicitation
Before taking action, collect clear evidence of any alleged solicitation or breach. Courts require proof that each client was actively solicited; suspicion or high client loss alone is insufficient.
Disclaimer
This update should not be treated as legal advice and only provides general information on the issues discussed.
