There are several ways in which a company might want to restrict the activities of an employee after his or her employment ends. These include preventing the employee from using or disclosing confidential information and trade secrets, going to work for a competitor, or poaching the company's customers, suppliers or employees.
All employees are under a legal obligation not to disclose their employer's confidential information and trade secrets or to use them for personal gain, and that obligation continues even after employees have left the company. However, if an employee is likely to have access to sensitive information in the course of his or her employment, it would be advisable to clarify and confirm the position by including an express term in his or her contract. This should identify the confidential information and emphasise the employee's obligation not to use it for personal gain or to disclose it.
If the company wishes to impose any other restrictions on an employee's activities after he or she leaves the company, it will need to obtain the employee's agreement to this, either by including the restrictions in the employee's contract or by agreeing them with the employee when he or she leaves. These restrictions are usually referred to as restrictive covenants, and can be used to limit a departing employee's ability to work for a competitor of the company, or to poach the company's customers, suppliers or employees.
The law starts from the assumption that any restriction that an employer places on an ex-employee's ability to participate freely in the marketplace is not in the public interest and is therefore not legally enforceable. This is the case unless the restriction is reasonable in scope and is necessary for the protection of the employer's legitimate business interests. In order to be enforceable, therefore, a restrictive covenant must be no wider than is necessary to protect the employer's legitimate interests. It must be reasonable in terms of:
- the subject matter it covers;
- the geographical area to which it relates; and
- the length of time for which the restriction lasts.
Restrictive covenants need to be drafted carefully if they are to be effective. Companies that wish to use restrictive covenants in their contracts of employment or as part of an agreement reached with a departing employee should therefore consider contacting their Association for advice.
If a company wrongfully dismisses an employee (wrongful dismissal ) as where the company does not give the employee proper notice of dismissal, the employee is released from his or her own obligations under the contract. This makes any restrictive covenants in the contract unenforceable. Some employers therefore insert terms into their employment contracts giving them the right to terminate either with notice or without notice but with a payment in lieu. If this type of term is in place, the employer will not prejudice the enforceability of post-employment restrictions even if it terminates the employee's contract without notice. However, the payment in lieu that the company makes under a contract term of this type is taxable in full, as it is treated as income from the employee's employment. A payment in lieu that is not paid under a contractual obligation can benefit from the £30,000 tax exemption for termination payments. (The rules on the taxation of termination payments are outlined elsewhere in this Guide (tax)).
If post-employment restrictions are agreed with a departing employee as part of a financial settlement, it is important from a tax perspective to identify the financial value of the restrictions. Payments for restrictive covenants are viewed for tax purposes as income from the employment and are taxable in full. If no separate value is attributed to the restriction, there is a danger that the whole settlement figure will be taxed in full, and the benefit of the usual £30,000 tax exemption for termination payments will be lost.