Be Reasonable: The Enforceability of Post-termination Restrictive Covenants

The impact on working arrangements caused by the pandemic has led many workers to re-evaluate what they want from a job, with considerations such as flexible and remote working becoming both more desirable and attainable. This is affecting businesses in all sectors, and the impact it can have not only on a business’s workforce but also on its customer base is far reaching.

One of the most important things to consider when a worker leaves a business is restrictive covenants. These are often contained in the employee’s employment contract, service agreement or, in some circumstances, shareholders agreement. Restrictive covenants are contractual restrictions that prevent individuals from doing certain things after their employment ends. Examples include non-compete clauses (preventing individuals working in competition with their previous employer) and non-solicit clauses (preventing individuals soliciting the customers and employees of their previous employer). Clauses protecting the use of confidential information are also often key. Preservation of a company’s connections, workforce and goodwill is vital for many businesses, so it is important to make sure these clauses bite when necessary. So, how do you do that?

The General Approach

The headline is that restrictive covenants will not be enforceable if they are considered unreasonable. This is a fact-specific assessment and a dynamic area of law. However, the courts aim to strike the balance between protecting a business’s interests and not unduly restraining an individual’s ability to work. To enforce a restrictive covenant, a business has to show that:

  1. There is a legitimate interest to protect. Examples of this include the business’s trade connections with customers and suppliers, confidential information and maintaining the stability of the workforce.
  2. The protection is no more than reasonable with regard to the interests of the parties and the public. This is assessed at the point at which the covenant is entered into, rather than at a later date. Both the time period and the geographical area that the restriction covers will be considered.

Recent Case Law

In Richard Baker Harrison v Brooks [2021] EWHC 2652 (QB), the court upheld the claimant’s claim to enforce restrictive covenants against two former employees. The claimant was a distributor of chemicals and minerals. The restrictive covenants contained in the former employees’ employment contracts were:

  • For 12 months following termination, prohibition on soliciting any customers, suppliers or employees
  • For 9 months following termination:
    • Prohibition on involvement with any customers of those parts of the business with which the employee was materially involved for the 12 months prior to termination
    • Prohibition on receipt of anything from the claimant’s suppliers that would affect the claimant’s business
    • Prohibition on employing any employee of the claimant
    • Prohibition on being involved in any business that competes or intends to compete with the claimant

At first glance, these restrictions appear quite wide.  However, the claimant argued that they were necessary to protect its legitimate business interests, namely confidential information and trade secrets, connections with suppliers and customers, business opportunities, and the stability of its workforce. The judge responded positively to this and agreed that the restraints were reasonably necessary for protection of these interests. The judge highlighted the fact that the defendants were able to obtain contracts with suppliers parallel to those that the claimant had, and were only prohibited from dealing with and soliciting customers of the claimant in the same commercial sector. This is therefore a good example of drafting qualified restrictive covenants that do not go beyond what is reasonably necessary.

Interestingly, the defendants in this case argued that all of the covenants should be three months shorter. However, the judge highlighted that a covenant will only be too long to be reasonable if a “much less far-reaching” covenant would suffice. In the judge’s view, a difference of three months was not “much less far-reaching”, demonstrating that the courts are unwilling to get into lengthy debate about the precise time period it is appropriate for a covenant to endure.

In contrast, in Dwyer (UK Franchising) Limited v Fredbar Limited [2021] EWHC 1218 (Ch), the court held that the restrictive covenants in the franchise agreement between the parties were not enforceable. The claimant, who was the franchisor of “Drain Doctor”, brought a claim against Fredbar Limited (a Drain Doctor franchisee) and Mr. Bartlett (guarantor for Fredbar Ltd). Mr. Bartlett had no prior experience of plumbing and drainage work prior to setting up the franchisee business, and he ran the business from his home.

After termination of the franchise agreement, Mr. Bartlett begun trading as “Daily Drains”. Dwyer took issue with this and attempted to prevent Mr. Bartlett from doing so. The post-termination restrictive covenants in the franchise agreement prevented Mr. Bartlett from being involved with a business similar to, or competitive with, the “Drain Doctor Business”:

  • Within the former franchise territory (save for having financial interest in such a business that did not allow him to influence the economic conduct of such a business)
  • That operated within five miles of the former franchise territory

Both of these restrictions were operative for 12 months after the termination of the franchise agreement. It was argued by Mr. Bartlett that these restrictions were too wide, because they left him unable to be employed by similar businesses even if there was no confusion with Drain Doctor, and unable to use his home as his registered office address even if operating elsewhere. The judge agreed with Mr. Bartlett. In particular, there was no definition of the “Drain Doctor Business” within the 100-page franchise agreement and so the judge interpreted the restrictions as preventing Mr. Bartlett from being involved in any plumbing or drainage business within the Cardiff territory. Essentially, this would mean that he was unable to work in the area for 12 months. The judge found this unacceptable, in terms of geographical scope and length of time. The other key consideration was the inequality in bargaining powers between Dwyer and Mr. Bartlett at the time the franchise agreement was entered into.

Eville and Jones v Aldiss [2022] EWHC 269 (QB) is a good example of how the seniority of an employee can affect a judge’s conclusion. The defendant was a shareholder and the joint managing director of the claimant company, and his shareholders agreement contained the following restrictions:

  • Prohibition on becoming involved with a business that has competed with the group during the last 12 months in a territory in which the group has operated during the last 12 months, while still holding shares
  • Prohibition on becoming involved with competitors in the territory, soliciting customers and/or soliciting employees for 18 months following cessation of the shareholders agreement

The judge concluded that the restrictions were reasonable and, therefore, enforceable. The judge took into consideration the fact that the defendant was the managing director, and, therefore, had a privileged position with access to a significant amount of confidential information.

How to Draft an Effective Post-termination Restrictive Covenant

As the above cases demonstrate, there are no hard and fast rules about what will be considered a reasonable restrictive covenant. However, a recurrent theme is that covenants should be appropriate for the particular circumstances of any given employment relationship, so it is important to bear in mind the bargaining power and seniority level of the employee. Covenants that are qualified so that they relate to specific parts of the business or specific geographical areas are typically more likely to be enforceable, as this assists the argument that they are proportionate to the legitimate business interest that they protect.

FLETF Released Strategy Guidance. Join SPB Webinar To Learn More!

Christmas came early this year.  Ok, not really, but the Department of Homeland Security, which chairs the Forced Labor Enforcement Task Force (FLETF) released its strategy guidance on the Uyghur Forced Labor Prevention Act on June 17, 2022—four days ahead of schedule.  Click here to view FLETF’s strategy guidance.

SPB will be hosting a webinar this Thursday, June 23, 2022 at 11am EST to discuss the Uyghur Forced Labor Prevention Act, FLETF’s strategy guidance and best practices for organizations in light of the new guidance. You may register for the event here.

SPB Partner In Law360 Discussing Ocean Shipping Reform Act of 2022

Yesterday, SPB supply chain partner Sarah Rathke was quoted in Law360’s article entitled, “New Ocean Shipping Regs On Deck, But Inland Woes Persist,” discussing the substance and likely impacts of the new Ocean Shipping Reform Act of 2022, which cleared Congress and is expected to be signed into law by President Biden soon.  Read more here.

CBP Issues Operational Importer Guidance Relating to UFLPA

 

Late Monday, June 13, 2022, Customs and Border Protection (CBP) issued its long-anticipated Operational Importer Guidance to guide importers before the Uyghur Forced Labor Prevention Act (UFLPA) enters into effect on June 21. As a reminder, beginning on that date, CBP will apply a rebuttable presumption that goods coming from the Xinjiang region violate a long-standing ban on the importation of goods made with forced, indentured, or prison labor.  CBP’s guidance is the first of documents expected to be released by federal government officials and provides preliminary background on the expected UFLPA’s process and enforcement, how to request exceptions to the rebuttable presumption, additional resources, and the types and nature of information that CBP may require.  The document is available on CBP’s website here.

No later than June 21, the Department of Homeland Security, which chairs the Forced Labor Enforcement Task Force (FLETF), is expected to release a broader strategy document required by UFLPA.  On June 23, we will be hosting a webinar on the FLETF strategy and CBP implementation efforts.  You can register here. We hope you can join us for this timely discussion.

CBP Hosts Webinar on Uyghur Forced Labor Prevention Act Implementation

On June 1, 2022, US Customs and Border Protection’s (CBP) Office of Trade Relations hosted a webinar on forthcoming implementation of the Uyghur Forced Labor Prevention Act (UFLPA).  Half of the webinar focused on the history, enactment, and text of the UFLPA (discussed in this blog’s previous posts here, here, and here), while the second half addressed questions from online attendees.

Starting June 21st, imports into the United States subject to the UFLPA will be subject to the detention process set out under 19 U.S.C § 1499.  As a result, any goods imported into the United States from the Xinjiang region will immediately be detained, excluded, or seized.  If an importer believes its goods are free of forced labor, then the importer will need to show by clear and convincing evidence that forced labor was not used to make the goods, or any input thereof, no matter how small.

During the webinar, multiple participants asked what evidence would be considered “clear and convincing” to overcome the rebuttable presumption.  While CBP officials did not list the exact evidence needed to overcome the presumption, they did indicate that the bar to rebut the rebuttable presumption will be very high and offered a few pieces of advice—such as submitting any evidence in English—to aid in a quick review of the evidence while goods are detained.

CBP officials also indicated that they will issue strategy guidance relating to the UFLPA within the next week, while the Forced Labor Enforcement Task Force will issue its required guidance on June 21st—the date UFLPA goes into effect.

The launch of UFLPA implementation later this month is expected to lead to significant delays, as CBP holds shipments and works to compile and submit the necessary information to rebut UFLPA’s presumption.  Our firm is working with clients daily to prepare for June 21st, including by reviewing supply chains and advising on CBP and the Forced Labor Enforcement Task Force’s guidance issued to date.

CBP Releases Known Importer Letters and Enforcement Guidance relating to the Uyghur Forced Labor Prevention Act

Earlier this year, U.S. Customs and Border Protection (CBP) released a statement on its website that it would be issuing letters to importers identified as having previously imported merchandise from locations or entities potentially subject to the Uyghur Forced Labor Prevention Act (UFLPA).  Well, CBP stuck to its word and just recently released two sample Known Importer Letters.

One of the letters is specifically directed to Customs Trade Partnership Against Terrorism[1] (CTPAT) members,[2] while the other is directed to other U.S. importers. Both letters notify recipients that they “previously imported merchandise from locations or entities potentially subject to the Act.”  The CTPAT letters also indicate that “subsequent entries of such merchandise may result in, among other things, suspension or removal from the CTPAT program, seizure, forfeiture and/or penalties, or other appropriate action under the customs laws.”  The non-CTPAT letters indicate that “any future entries of such merchandise may be subject to CBP enforcement action, including seizure, forfeiture and/or penalties, or other appropriate action under the customs laws.”  You can view the text of each letter here.

In each letter, CBP urges importers to be proactive and closely review their supply chains to ensure that goods or materials are not sourced from Xinjiang in violation of the UFLPA.  The burden is on importers to apply due diligence, effective supply chain tracing, and supply chain management to ensure all imports are free from forced labor.

If you or your organization have not received a Known Importer Letter from CBP, this does not mean your organization is in compliance with the UFLPA or that your supply chain is free from forced labor.  All organizations are expected to review their supply chains thoroughly to ensure goods are not produced with forced labor.

In addition to the Known Importer Letters, on May 20, 2022, the CBP released guidance on enforcement mechanisms under the UFLPA.  CBP’s detention authority for goods imported from Xinjiang arises under 19 CFR § 151.16.  Pursuant to 19 CFR § 151.16 (b), within the 5-day period (excluding weekends and holidays) following the date on which merchandise is presented for CBP examination, CBP shall decide whether to release or detain merchandise. Merchandise which is not released within such 5-day period shall be considered to be detained merchandise.

Under 19 CFR § 151.16 (c), if a decision to detain merchandise is made, or the merchandise is not released within the 5-day period, CBP shall issue a notice to the importer or other party having an interest in such merchandise no later than 5 days after such decision or failure to release.[3]  The notice of detention is not to be construed as a final determination as to admissibility of the merchandise.  Final determination with respect to admissibility of detained merchandise will be made within 30 days from the date the merchandise is presented for CBP examination, and such determination may be the subject of a protest.[4]  19 CFR § 151.16 (e).

CBP anticipates releasing additional strategy and guidance in advance of the UFLPA taking effect on June 21, 2022.  We are tracking the CBP releases and UFLPA closely, so stay tuned for additional updates.

[1] CTPAT is a voluntary public-private sector partnership that works with CBP and the trade community to strengthen international supply chains and improve US border security.  The Security and Accountability for Every Port Act of 2006 provided a statutory framework for the CTPAT program and imposed strict program oversight requirements.

[2] The members include U.S. importers/exporters, U.S./Canada highway carriers; U.S./Mexico highway carriers; rail and sea carriers; licensed U.S. Customs brokers; U.S. marine port authority/terminal operators; U.S. freight consolidators; ocean transportation intermediaries and non‐operating common carriers; Mexican and Canadian manufacturers; and Mexican long‐haul carriers, all of whom account for over 52 percent (by value) of cargo imported into the U.S.

[3] The contents of the notice are outlined in 19 CFR § 151.16, which you can view here.

[4] 19 USC § 1514 outlines the Protest process against decisions by CBP of any detained merchandise.

“Is Your Organization Complying With the US Uyghur Forced Labor Prevention Act?” 

The Uyghur Forced Labor Prevention Act goes into effect on June 21, 2022.  The Act creates a rebuttable presumption that “any goods, wares, articles, and merchandise mined, produced, or manufactured wholly or in part in the Xinjiang Uyghur Autonomous Region of the People’s Republic of China” (or by an entity included on a list required by the Act) is prohibited from importation into the US under 19 U.S.C. §1307.  What does this mean for your organization?  Click here to find out.

The Effects of the Military Conflict in Ukraine on Supply Contracts

Our colleague, Dr. Christopher Eggers,  prepared an insight on how the effects of the military conflict in Ukraine are serious, far-reaching and, ultimately, unforeseeable at the present time. Supply relationships will not remain unaffected, and there are numerous questions regarding the consequences under contract law. Read our full insight.

 

 

Supply Chain Investigations and Legal Privilege

Regulators worldwide are increasing their demands that manufacturers and retailers know and understand all aspects of their supply chains as they relate to Environmental, Social, and Governance (“ESG”) goals. Keeping the findings, communications, information, and reports generated in connection with supply chain ESG investigations is imperative to ensure full and candid fact-finding and to manage brand integrity effectively. However, maintaining legal confidentiality is challenging when an investigation includes fact-finding of third parties such as suppliers.  To learn more on how to keep internal investigations privileged, click here.

Raw Material Surcharges Again on the Cartel Radar – German Authority Raids Cable Companies

In one of the first dawn raids of the New Year, the German competition authority have raided the premises of several cable manufacturers. The investigation arose in response to alleged coordination of metal surcharge calculations.

Metal and other raw material surcharges are used in many industries, in addition to the negotiated price, to allow for short-term changes in the metal/raw material procurement costs. They are particularly prevalent where the surcharge accounts for a high proportion of the final products’ total manufacturing costs.  Often, the mathematical formula used to calculate the surcharge is linked to prices quoted on exchanges, and therefore increases or decreases the price automatically.

Despite companies’ increased awareness of the limitations of antitrust and competition laws, surcharge reviews may fall through the gaps of compliance programs.  This may be due to, firstly, there being cut-throat competition in the industry on the base price, with the surcharge perhaps being in place for a decade or more, and secondly, because surcharges are in themselves a permissible instrument for passing on changes in raw material prices quasi automatically into the overall selling price of products, without the need for new negotiations.

However, suppliers are prohibited to form arrangements where they agree to introduce or maintain such a surcharge as a standard throughout the industry, thereby eliminating competition by way of other pricing models.  In past cases, authorities have found that even where the formulas for the calculation differed – the fact the concept had been agreed (potentially decades ago) was anticompetitive.  There have been a number of cases in the past, notably on quarto plates and steel, with the most well-known being Airfreight.  Here, airlines were found to have allegedly agreed fuel and security surcharges.  The case is still pending before the European Courts.

The recent raids on cable manufacturers are a reminder that companies using similar price mechanisms are well advised to review the origins of any surcharge formula to ensure there is nothing historically that could be construed as an agreement or concerted practice to implement a surcharge or continue to apply it.

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