Post-termination restrictive covenants in the financial services sector

When an employment (or other contractual relationship) comes to an end, the potential misuse of confidential information and/or the loss of client relationships can give rise to harsh, and potentially very costly, consequences for the business. This is a particularly important consideration for financial advisory firms, professional services firms and business acquirers, where the preservation of client relationships is key.

For that reason, many businesses in the financial services sector try to protect themselves in the case of a departing employee/adviser by seeking to rely on post termination restrictive covenants ("PTRs"). In this article, we consider the extent to which PTRs are enforceable.

What are PTRs?

PTRs are contractual clauses which prevent a departing employee from using information or contacts that they have gained, either for their own benefit or for the benefit of their future employer. They are particularly important in the context of senior employees, who will frequently have considerable influence over staff, access to significant confidential information and relationships with key clients.

Main types of PTRs

• Confidentiality clauses - these aim to protect company/trade secrets and/or other confidential information, such as customer and pricing lists
• Non-solicitation clauses – these seek to prevent departing employees/consultants/financial advisers from soliciting or contacting clients or customers of the business for a specified period with a view to providing similar services or products to them
• Non-dealing clauses – these seek to prevent employees from dealing with former clients of the business. These clauses should be distinguished from non-solicitation clauses as they aim to prevent the departing employee from dealing with a client at all, even if that client approaches them of their own volition
• Non-poaching clauses – these seek to prevent the poaching or enticing of employees away from the business
• Non-compete clauses – these aim to restrict competition for a specified period, and sometimes also within a specified location

Enforceability

For public policy reasons, clauses which attempt to impose onerous restrictions on rights to compete are generally not enforceable, as they are viewed as unreasonable restraints of trade. However, in recent years, the Courts have been prepared to enforce restrictions if they are drafted in a manner which meets the following two key criteria:

• The clause seeks to protect a legitimate business interest
• The protection sought is no more than is reasonably necessary to protect that business interest

Legitimacy and reasonableness are therefore the key considerations.

Protecting a legitimate business interest

Precisely what constitutes a legitimate business interest depends on the nature of the business in question. A business cannot restrict an employee from activities which do not compete with its business. However, legitimate business interests which can be protected include trade secrets and/or confidential information, connections with clients and the stability of staff. PTRs are also more likely to be considered enforceable for senior and/or key employees, as they present the greatest risk to the business.

Restriction reasonably limited in time

An important consideration is the duration of the PTRs and, in particular, how long the business requires the restrictions to remain in place. Relevant factors include:

• The time that it would take for a replacement employee to build good client relationships
• The likely time that the information should remain confidential in the hands of the departing employee (i.e., not in the public domain). In other words, how long it will be before the information is out of date

As a general rule, restrictions of between 6 and 9 months stand a better chance of being considered reasonable and therefore enforceable. However, each case will turn on its own facts.

In the recent case of Merlin Financial Consultants Ltd v Cooper [2014] EWHC 1196 (QB), the parties entered into a business sale agreement, as opposed to an employment contract, and the PTRs in question were contained in that agreement. The Court upheld a 12 month restrictive covenant on the basis that (a) PTRs of that duration were common in the financial services industry, and (b) there was an equality of bargaining power between the parties in light of the nature of the agreement between them.

Restriction reasonably limited in geography

In general terms, the greater the extent of the geographical area involved, the greater the potential restraint on trade.

This means that a Court would be more likely to hold the restriction to be unenforceable, unless it is strictly necessary to protect legitimate business interests. Factors to take into account in this regard include the area of activities of the party subject to the restriction, the size and nature of the population of the area and, most importantly, whether there is a relationship between the interest to be protected and the chosen geographical area.

Remedies for breach

Where a PTR has been breached, there are a number of potential enforcement options:

• An emergency injunction (known as a "springboard injunction") may be sought in an attempt to prevent the breach causing serious economic loss/potentially irreparable damage to the business in circumstances where damages are not an adequate remedy. The aim of the injunction is to put an immediate stop to what the defaulting party is doing, pending a full trial of the issue
• Damages for financial losses
• An order for an account of profits
• An order for the delivery up of documents that could be used for the benefit of competitors

Unfortunately, however, there is no guarantee that a PTR will be upheld. The enforceability of PTRs will turn on the specific circumstances of the case and the construction of the particular clause(s) in question. It is important to bear in mind that a PTR may be declared void in its entirety if it is held to be unenforceable such that the employee or contracting party would be free to act as if there had never been a restriction at all.

It is therefore worth investing in legal advice at the outset to ensure that any restrictions are appropriately drafted and, in particular, are likely to be enforceable. This will minimise the potential for future problems and costly disputes to arise. If a dispute does arise, it is crucial that legal advice from a specialist dispute resolution lawyer is sought as soon as possible.

For advice or guidance, please contact me on +44 (0)1752 675078 or email [email protected]