How to handle restrictive covenants

There are four varieties of restrictive covenants: non-compete covenants, non-solicitation covenants, non-dealing covenants, and covenants forbidding the solicitation of employees. They all restrict the freedom of former employees to do their own thing, but in subtly different ways.

For example, non-solicitation covenants state that former employees should not solicit their former clients for a competing business. But non-dealing covenants require that former employees should not have any dealings with former clients.

For a specified period, non-compete covenants, prohibit former employees from working for competing firms. Non-solicitation of employee covenants prevent leavers from poaching former colleagues.

Covenants are typically incorporated in employment contracts, hence the need to watch what you sign. Mark Watson, an employment partner at solicitors at Fox Williams, says they are widespread in investment banking: 'Most trading and client facing roles are covered by restrictive covenants, at both junior and senior levels of the firm.'

Watson says non- solicitation of employees, and non-dealing covenants are most common in banking roles. Team moves, for example, are complicated by rules preventing the solicitation of employees. 'If you openly seek to take your team with you, you will be in breach of your contract and duty, with potential financial consequences', Watson cautions.

However, covenants may be less restrictive than they seem. Lawyers say banks are frequently loathe to enforce non-dealing and non-solicitation covenants for fear of irritating clients. Even if they are willing to fight their corner, David Dalgano, an employment lawyer at law firm McDermott Will & Emery, said courts have decided that most covenant decisions are unenforceable.

The main sticking point is so-called restraint of trade. Common law entitles individuals to work freely and without undue restraint. Dalgano says covenants are therefore effective only when the employer can prove that they have a 'legitimate protectable interest'. The onus falls entirely upon the employer to prove that this is so.

Dalgano says one example of a legitimate covenant would be the protection of a confidential trading position. 'Traders can have serious positions that are not unwound for some time. A competing bank could use an ex-employee's knowledge of a strategy to sell Vodafone shares in twelve months time to frustrate the successful sale.'

Restraint of trade makes it harder to enforce a covenant when an employee has been made redundant. Michael Moran, managing director of Penna Meridian, the outplacement firm, says covenants are usually rendered irrelevant by redundancy. 'Employers can't say employees are no good on one hand, only to prevent them from working anywhere else on the other.'

Even when covenants are enforceable, there may still be ways of overcoming them. Watson says non-solicitation of employee covenants are often overcome during team moves. If the new employer is aware of the identity of other team members, it can approach them directly.

Team members may still talk among themselves about the move, but all conversations should be in private. 'Avoid emails, or telephone calls on recorded telephone lines', Watson advises.

Going against a covenant can be a costly business. Employees who are found to be in breach of covenants may be asked to pay their former employer's legal costs, as well as damages related to unlawfully gained profits.

While it helps to be aware of their existence, attempts to evade covenants may be futile. Watson says: 'People don't take enough care of what they are signing. But the unfortunate fact is, that unless you are very senior there is often very little room for negotiation anyway.'