UK: Casting The Net: Restrictive Covenants For Web-Based Businesses

Last Updated: 23 July 2012
Article by Kemp Little’s Employment Pratice Group

In today's challenging economic climate, many companies are working extra hard to bring in business, and those which are doing well are trying to ensure continued success.  But their efforts may be in vain unless the company is protected against rogue departing employees who might otherwise make off with valuable business information.  All too often, such employees will use their knowledge and relationships with clients, distributors, colleagues and / or suppliers for the benefit of their new employer - a competing business. 

At this stage, the former employer may pick up the phone to lawyers such as us, asking what can be done.  The first thing any lawyer will ask is to see a copy of the individual's employment contract, which will hopefully contain some post-termination restrictions on working for a competitor, soliciting customers, poaching employees and the like.  But the degree of protection offered by such restrictions depends entirely on how well they are drafted.  It is well established that post-termination restrictions on employees are, on the face of it, unlawful restrictions on trade.  Because of this, the courts will only enforce such restrictions where they go no further than necessary to protect the legitimate interests of the business.  But what does that actually mean?  Case law provides some guidance– but much of it is outdated and does not reflect the digital age in which we now live.  We have found that some creative thinking is required when it comes to protecting less traditional types of businesses – particularly those which are web-based. 

In the paragraphs that follow, we draw on our experience of advising online businesses and set out some ideas to consider when drafting restrictions for such companies.  These considerations will be relevant both to restrictions in service agreements for employees, and transactional documents, such as a sale and purchase agreement, although the courts tend to take a more lenient approach to restrictions imposed as part of arm's length commercial transactions, as opposed to those which form part of an employment relationship.

The "what" – defining the business

Often, the most powerful way to protect your business against departing employees will be to prevent them from working for a competitor for a defined period following termination.  This sounds simple, but because of the onerous impact of such "non-compete" provisions on individual employees, they must be carefully worded in order to stand a chance of being upheld in the courts.   In order to articulate who your competitors are, you need to first define your own business.  For fast-paced technology companies, this may not be easy – they may quickly move into different areas, meaning that by the time the employer comes to rely on the restrictions, the focus of the business has changed significantly.    Cast the net too broad and the restriction risks being invalid; define the business too narrowly and you may not have adequate protection.

One way of addressing this is to have separate clauses restricting the employee from working for companies competing with the employer's existing business, and its prospective business.  It is also important that the definition of the business is limited to areas with which the employee was directly involved prior to his departure – as the employer has no legitimate interest in stopping the employee from competing in areas with which he had no prior involvement.

The "where" – establishing the appropriate geographical reach of the restrictions

The geographical scope of internet businesses may change rapidly, almost overnight, meaning that in an ideal world, the company would like to be protected globally.   Traditionally, courts have taken the view that the wider the geographical area, the less likely it is that the restriction will be enforceable.   However, whether this is still true depends very much on the nature of the interest being protected.  If the purpose of the non-compete is to protect confidential company information, there is a persuasive argument that the restriction must be worldwide, given that information can now be dispersed globally at the click of the button.  In contrast, if the purpose of the restriction is to protect customer or other critical business relationships, the scope of the restriction must correspond with the location of the clientele or other key business. 

When asked where their customers are based, some of our clients have told us that they are potentially in every country in the world.  In this case, it becomes necessary to look at market share in each jurisdiction.  By applying a threshold of, say, ten per cent of market share, the company can identify which jurisdictions can legitimately be covered by the restriction.

An additional complication which arises with internet businesses is that they can be run from any location, meaning, for example, that an individual may operate a business targeting a European market from the United States or some other jurisdiction.  In cases where the geographical reach of the restriction is limited to certain markets in which the employer is operating, it will therefore be necessary to stipulate that the employee is not permitted to operate a business from anywhere in the world where that business competes in the market that the employer is in.  The reality is of course that no matter how well drafted the restrictions are, there will be practical difficulties associated with enforcing them against former employees who have moved abroad.

The "who" - identifying the relationships you want to protect

The courts have always recognised that it is legitimate for businesses to protect their customer relationships.  But the customers of internet businesses will often be in their millions and will have no personal contact with anyone at the company – interacting solely through the company's online user interface.  In this scenario, the former employee will have no special influence over the customers.  It cannot therefore be said that the company has a legitimate interest in preventing such employees from soliciting or otherwise dealing with its customers.   

The customer base may also not be easily identifiable, meaning the former employee would have no way of ensuring that he or she did not inadvertently contact a customer during the course of marketing activities on behalf of a new employer.  Case law makes it clear that non-solicitation covenants will not be enforceable in these circumstances.   However, it might be legitimate for the employer to require the former employee not to knowingly interfere with its customer relationships. 

Scratch beneath the surface and you will probably find that there are also other business relationships which are critical to the company and which have features more akin to a traditional customer relationship, such as personal connections built up over time between the individuals involved.  For example, a music streaming service provider may place a high value on its exclusive relationships with record labels, without which, it would fail.  Equally a company selling online advertising may have no direct relationship with the "customers" of the site – those who buy the products and services being advertised, and it will not have a protectable relationship with the millions of advertisers using the site.  But there may be agents placing multiple adverts who are very important to the company and who can be identified.  Once these critical business relationships have been identified, there is no reason in principle why they cannot be protected, provided that the scope of the restrictions is sufficiently precise.  Again, this would be done by way of a non-interference clause.  While such clauses have been upheld in the context of protecting supplier relationships, it does however remain to be seen exactly what approach the courts would take in relation to non-interference with customers, agents etc.

The "when" – for how long should the restrictions apply?

This again comes down to the nature of the interest being protected.  Where the goal is to protect confidential information, a court will ask what the shelf life of that information is – i.e. when it will cease to be current.  If the aim is instead to protect customer relationships or other key business connections, the question is how long it would take the company to recruit replacement staff and for such employees to establish connections with customers.  This in turn depends on the degree of customer loyalty, which may be closely connected with the industry's specific sales cycle.  For example, in the insurance business, the courts have placed emphasis on the fact that many insurance policies are renewed annually, which gives weight to one year being the appropriate duration for post-termination restrictions in this context.

When deciding on the appropriate duration, it will also be necessary to factor in the role performed by the employee you are seeking to restrict; onerous restrictions with a long duration will only stand up to scrutiny if they are applied to employees who pose a real threat to the business on departure.  These are likely to either be very senior staff, such as directors, or those who are otherwise key employees, such as salespeople.  In either case, it will also be necessary to think about why they pose a threat – for example, a finance director may have access to lots of confidential information but is unlikely to have formed relationships with clients.  In this situation, the only legitimate interest the employer may have in restricting the employee will be in relation to protecting confidential information.

We know that a "cascade" approach of listing varying durations and asking the court to strike out those which are deemed too long does not work in the UK (unlike in some other jurisdictions).  This means that some analysis must be done before the duration of the restrictions is decided on.  It may be helpful to document this analysis so that it can be relied upon should the restrictions be tested in court.  At the time of writing, it is generally accepted that twelve months is the longest duration which is likely to be acceptable in an employment context.   In the scenario where the individual is a shareholder signing up to a sale and purchase agreement, a restriction in the region of two years may be valid.

Final thoughts

With inspirations such as Huddle's recent $24m Series-C round investment, a $10 million dollar kickstarter project, and Google's recent back to back acquisitions of Meebo and Quickoffice there never has been a more exciting time to run an online business.  This makes it all the more vital that these companies put appropriate protection in place early on to ensure they can retain the value of their business when the time comes to seek investment or sell.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.