Articles

Protecting Corporate Assets - restrictive covenants for employees

Protecting Corporate Assets - restrictive covenants for employees

Protecting Corporate Assets - restrictive covenants for employees

Wednesday, 24 June 2009 14:15

 The most important asset of any business is confidential and proprietary information.


This can include client and customer databases, marketing strategies, modeling tools, trade secrets and anything else that gives an organisation a competitive edge over its rivals. It is also one of the most difficult assets to protect.

Employees, and in particular, senior employees and directors, often pose the greatest risk to the business they work for as they are privy to confidential and sensitive information from the very outset of their employment. Whether an employee has long service or is a recent newcomer, the employer is always at risk that an employee may defect and use the confidential or proprietary information to gain a competitive advantage. This can include working in competition, poaching clients and/or soliciting key members of staff.


Despite the significant risk to their business, the steps taken by many companies to protect their confidential and proprietary information are often ineffective or inadequate.

Basic Protection - Implied Duties

The law provides a basic level of protection to all organisations by way of implied duties and obligations that all employees owe to their employers.

These implied duties and obligations include a duty of loyalty and fidelity to the employer and the prevention of unauthorised disclosure or use of confidential or proprietary information by the employee either during or after their employment.

In the case of the most senior employees and directors, additional and enhanced duties apply, which are often referred to as fiduciary duties. Whilst these fiduciary duties can be wide reaching, they, together with the basic duties that all employees owe, are often insufficient to provide full protection from a former employee setting up or acting in competition utilizing know-how and information learned in that former employment.

 

Restrictive Covenants

Although the Hong Kong law will assist in preventing employees from taking physical items containing confidential and proprietary information, such as documents, disks and USB devices, in practice, given the number of ways in which confidential information can be stored and dispatched, with email and remote access being of particular concern, it is often impossible to fully prevent employees from taking such information.

An additional concern comes from the inherent difficulty of determining what is and is not confidential or proprietary information.

The law has long recognised that in most cases the most appropriate way of protecting confidential information is by imposing restrictive covenants.

The purpose of restrictive covenants is usually to limit an employee's ability to take up alternative employment and/or engage in competitive activities, on their own account, once the employment relationship has come to an end.

 

Key Requirements for Enforceability

There are a number of key requirements that must be taken into consideration for a restrictive covenant and in particular a non-compete restriction to be held enforceable in Hong Kong.

The first and most important requirement is that the parties must have agreed to the restrictive covenant.  The most usual way would be for the restrictive covenant to be a term of the contract of employment, which is then signed by both the employee and the employer. Alternatively, the restriction can be contained in a separate agreement between the employee and employer. Whilst this might seem to be very basic, it is frequently overlooked and only becomes an issue once the employee gives notice to bring his employment to an end.

If a restrictive covenant is contained in an employment contract, the next consideration is whether that restrictive covenant is actually enforceable. This is a complicated and vexed question, which requires a careful analysis of the facts and circumstances. When considering the enforceability of a restrictive covenant, the Courts must balance the freedom for parties to contract and the protection of an employer's business with the concern of stifling competition and preventing an employee from earning a living.

The often cited test for the enforceability of a restrictive covenant is: 'it must serve to protect the employer's legitimate business interests whilst being no wider than reasonably necessary to do so'.

This legal test does not really assist employees, employers or, indeed, their legal advisers who are often requested to advise whether a restrictive covenant is enforceable, usually in very tight time frames with often with thousands, if not millions of dollars riding on the advice.

 

Legitimate Business Interests

The most common business interest that employers wish to protect is usually their client/customer base and, therefore, any database or customers list is often seen as a high priority for protection.

In addition, employers in specialised industries also wish to protect other confidential information and know-how, whether this is in the form of trade secrets or formulas or technology that has been created by the employer, usually with the investment of considering the time and financial resources.

In addition, employers also wish to maintain a stable workforce and a carefully drafted 'non-solicitation of employees' restriction can go a long way to prevent departing employees from poaching the rest of the team or a desk.

 

Reasonableness

The three key considerations when considering the reasonableness of a restrictive covenant are:

(i) Duration;

(ii) Geographical scope

(iii) Nature

 

In respect of both duration and geography, the test is again that the restriction must go no further than is reasonably necessary to protect the legitimate business interests of the employer.

Case law in Hong Kong and overseas common law jurisdictions shows that Courts can and will, in certain circumstances uphold restrictive covenants with long durations. There are numerous cases where the duration of 12 months has been held to be unreasonable, which has incorrectly led to the assumption that 12 months is always too long and will always be unreasonable. This is not the case and there is also a large number of cases where a duration of 12 months and even longer has been held to be reasonable, including in one case, involved equity partner with equal bargaining power in a law firm, being held to the 5 year restrictive covenant that was included in a partnership deed.

Similarly, the assumption that a duration of six months will usually be held to be reasonable is also incorrect and a six month duration has been held to be unreasonably long.

The law regarding geographical scope is similar to duration and it may be reasonable for a geographical restriction to relate to a certain road or neighbourhood. Equally, however, it can also be reasonable for a restriction to cover a whole region, country and, potentially, the entire world.

 

The third consideration of nature relates directly to the meaning of 'legitimate business interests' since the restriction must relate to the business of the employer and the work undertaken by the employee.  In many industries, especially financial services where many products of varying natures are traded in the market, it is often very difficult to precisely indentify the precise nature of the business that is to be protected and what will fall outside the test of reasonableness.

One thing is certain in all matters concerning restrictive covenants, from their drafting to taking enforcement action, is that each situation/ circumstance must be treated individually and with a full consideration of the relevant facts.

 

The Employment Practice Group at OLN advises on all aspects of restrictive covenants for both employers and employees and are regularly instructed to take urgent action to prevent the unlawful use of sensitive and confidential information.



This article is for information purposes only. Its contents do not constitute legal advice and readers should not regard this article as a substitute for detailed advice in individual instances.

More in this category: Reserve Directors »