Atypical restrictive covenants

Businesses have long relied on restrictive covenants in employment contracts to protect their business interests, such as market position and stability of their workforce, on the departure of an employee. Non‑compete, non-dealing, non‑solicitation and non‑poaching clauses remain popular tools in safeguarding commercial interests when key employees move on.

However, most recent remuneration practice means many businesses now rely on other provisions which, while not labelled as restrictive covenants, may operate in a similar way. Embedded within bonus schemes, long‑term incentive plans or share schemes, these clauses can discourage employees from leaving by making their departure financially unattractive.

These mechanisms are not always labelled as restrictive covenants, yet their practical effect can be to dissuade an employee from leaving or joining a competitor, raising enforceability questions similar to those associated with traditional restrictive covenants. Organisations who make use of deferred remuneration and complex incentive structures should recognise when these terms may be viewed as 'atypical restrictive covenants' and ensure they are drafted and implemented lawfully.

What are 'atypical' restrictive covenants?

A covenant is 'atypical' when it does not expressly restrict competitive activity, but in substance, limits the employee’s freedom to move roles or work elsewhere. Courts assess the impact of these terms applying what is known as the 'restraint of trade' doctrine and look at whether the clause influences the employee’s ability to change employment.

The following commonly used arrangements may fall into this category:

• Deferred remuneration schemes - Deferred bonus schemes, long-term incentive plans and clawback provisions can deter employees from leaving because departure may result in forfeiture of significant sums. Such schemes are widely used, particularly in regulated sectors, and have been treated as potential restraints where their effect is to tie employees to the business.

• Employee share schemes - Complex vesting rules or good and bad leaver provisions in share plans may result in loss of valuable equity if the employee leaves a business to join a competitor, making these arrangements a potential indirect restraint.

• Repayment of training costs - Clauses requiring repayment of training fees if employees leave within a defined period can discourage early departure. They may amount to a restraint if they go beyond what is necessary to protect the employer’s investment.

Each of these can be perfectly legitimate in isolation. The legal risk arises where the mechanism is structured or applied in a way that ties the employee to the business rather than protects a legitimate business interest.

By way of illustration, in Sadler -v- Imperial Life Assurance Co of Canada [1988] IRLR 388, the High Court held that a clause withholding substantial renewal commission if the employee joined a competitor after leaving a business amounted to an unlawful restraint of trade. The employee, Mr Sadler, was entitled to ongoing commission for up to ten years after each policy sale, but his contract provided that all outstanding commission would be forfeited if he subsequently took up employment with a competitor. When he did so, the employer sought to rely on the forfeiture provision. The court found that the clause operated as a direct financial deterrent to working elsewhere and thus restricted his freedom to choose future employment. It was therefore void as an unreasonable restraint of trade

In contrast, courts have upheld provisions that merely require an employee to remain employed until a payment date, without controlling or penalising post‑termination competitive activity. The reasoning in cases such as Peninsula Business Services Ltd -v- Sweeney [2004] IRLR 49, is that an economic disincentive is not necessarily a restraint of trade where the employee remains free to work for a competitor after leaving and the scheme does not seek to control that future activity.

Enforceability issues around 'atypical' covenants

Difficulties commonly arise where an employee wishes to leave a business, often to join a competitor, but is reluctant to lose the value of deferred remuneration or other accrued benefits. In those circumstances, disputes tend to focus on whether the contractual mechanism withholding that value operates, in substance, as a restraint on the employee’s ability to move to another role.

The central question is therefore whether the clause triggers the doctrine of 'restraint of trade'. If it does, the clause will be unenforceable unless (i) it protects a legitimate business interest and (ii) it goes no further than reasonably necessary to protect that interest.

In determining whether an atypical provision amounts to a restraint, courts consider a range of factors including:

• Whether the clause actually restricts an employee’s freedom to work elsewhere;

• The practical impact of the provision;

• Whether such provisions are customary in the relevant sector;

• Whether the scheme seeks to incentivise performance or restrain competition; and

• Whether the restraint operates during or after employment.

Implementing incentive schemes that can actually be enforceable

To maximise enforceability, employers should begin by ensuring that the purpose of the incentive scheme is clearly defined. Courts will look at the substance of the arrangement to determine whether it is genuinely designed to reward performance, increase motivation and encourage loyalty, or whether its real effect is to penalise employees for leaving. Where the language and operation of a scheme demonstrate a legitimate incentive‑based purpose, rather than an attempt to deter competitive exits of the business, it is far more likely to withstand scrutiny under the restraint of trade doctrine.

Once the purpose of the scheme is clearly established, the next essential step is precision in drafting. Courts expect, for instance, good and bad leaver provisions to be articulated in clear, objective terms. Where the employer retains discretion, this should be exercised consistently and supported by a clear record of the factors considered. Employers must also ensure the scheme is properly incorporated. Employees should receive and acknowledge the relevant plan rules, and any changes to those rules must be clearly communicated.

Conclusion

As businesses increasingly rely on deferred remuneration, share based incentives and contractual mechanisms to retain key talent, atypical restrictive covenants have become a common feature of the employment landscape. While these arrangements can be powerful commercial tools, they carry the same enforceability risks as traditional restrictive covenants when they operate to restrict employee mobility.

We can help employers structure such schemes carefully, focusing on clear drafting, legitimate commercial aims and proportionate consequences that will help such schemes avoid falling foul of the 'restraint of trade' doctrine.

We can also review all existing schemes and produce a ‘gap-analysis’ report setting out the areas where the business is exposed if the clauses in place could be construed to be a restraint of trade.

Finally, when an employee does leave, we can help businesses to decide what action should be taken in order to protect their interests and, if legal action arises as a result of the action taken, we manage the litigation process, liaising with specialist experts (such as barristers and forensic IT service providers) as required, in order to achieve a successful commercial resolution.