By Karen Holden
If a founder or shareholders or senior managers relationship sours, things can go wrong very quickly causing the company distraction and financial losses.
This is compounded if on exit the departing individual seeks to poach clients or staff seeks to work with a competitor or sets up in direct competition with you. The best way is to deter this behaviour and have the means to take action against them if they choose this route.
We’re tackling an issue that can make or break your business—restrictive covenants and their role in protecting your company during shareholder, director or staff disputes. We will touch on their importance, how these should be incorporated into your documents and what should be included.
Restrictive covenants
Restrictive covenants are clauses in contracts designed to protect your business from those who know it best, know your trade secrets, clients and confidential information these include your directors, shareholders, founders, and key employees.
These covenants seek to deter them from walking away with your clients, staff, or even setting up a competing business immediately after leaving and if they choose to do this gives you a means to take legal action to stop this and/or seek compensation for your losses.
Without restrictive covenants, when relationships turn sour, your company becomes vulnerable. Whether it’s a co-founder leaving the company or a senior director moving on, the risk is the same. They could take with them valuable knowledge, contacts, and influence potentially creating a rival business or poaching your team and clients unless deterred from doing so
The Importance of Restrictive Covenants
For shareholders, directors, and senior staff, the stakes are particularly high. That’s why restrictive covenants for these individuals are often set for longer periods typically 12 months or more.
For other employees, 3 to 6 months might suffice, but for those in key positions, longer restrictions are essential to give your business the protection it needs.
Caution of reasonability
They need to be clear and reasonable though as you cannot stop someone from working unreasonably, as this would be considered a restraint of trade – for example, you cannot stop an employee working for a non-competing business located near you in London, as there is no conflict or potential loss. If it is a competing business though then this changes things.
Types of Restrictive Covenants
- Non-compete clauses prevent them from setting up or joining a competing business within a defined sector, geographic area and/or timeframe.
- Non-solicitation clauses stop them from approaching your clients or employees. You can also widen the net to prevent them from approaching potential clients you have had contact with, or suppliers or marketing platforms you utilise
- Non-dealing clauses go a step further, ensuring they cannot do business with your clients at all, even if the client approaches them.
- Confidentiality clauses protect your sensitive business information trade secrets or market strategy from being used against you or disclosed to third-party competitors
“But, it’s not just about adding these clauses to your contracts and hoping for the best. The wording and legal framework of these restrictive covenants must be carefully considered to ensure they are enforceable. Courts will strike down clauses that are too broad or unreasonable, so it’s crucial that they are tailored specifically to your business’s needs.”
Creating and Implementing Restrictive Covenants
This is where policy comes into play. Your company should have a clear policy in place that covers restrictive covenants for all key roles. Make sure these clauses are embedded or considered legally binding in every relevant agreement—from employment and director’s contracts to shareholder agreements.
Timeframe
When drafting these provisions, think about what’s reasonable and necessary. For example, a 12-month non-compete clause might be vital for a departing director, but too restrictive for a junior employee. Tailor the duration and scope based on the individual’s role and access to your company’s assets, clients, and strategic information.
Remember, these clauses must align with legal standards. Overly restrictive covenants can be challenged and invalidated in court, leaving your business exposed. This is why it’s important to work with legal experts to ensure your agreements are solid, enforceable, and compliant with the law.
A separate policy is also advisable so if they seek to argue the company has breached its employment contract, for example, an unfair dismissal claim, this can potentially invalidate the restrictions. If this is signed as a separate but binding agreement this future proves your right to enforce these.
Summary
In short, restrictive covenants are a powerful tool for protecting your business, but they need to be implemented with care. Whether you’re dealing with a departing founder, a shareholder dispute, or just looking to safeguard your company from future risks, having the right provisions in place is essential. We specialise in crafting tailored agreements that protect your business interests while standing up to legal scrutiny. If you need assistance with drafting or reviewing your restrictive covenants, we’re here to help.
About the author
Karen Holden is the founder of A City Law Firm an innovative firm working in emerging tech, but which offers personal service. She was admitted to the role in 2005 having obtained her degree in law and her Masters from the University of Cambridge and her LPC from the College of Law. She is an entrepreneur having developed a thriving corporate firm from scratch; establishing the female founder’s growth programme to help founders get investment ready and was the winner of the WeAreTheCity Champion award.
Karen was given freedom of the City for her work in equality and speaks at many venues including the House of Lords and tech hubs and universities on starting, scaling and selling your business.
