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Restrictive Covenants in Employment Contracts

This article discusses restrictive clauses and confidentiality clauses in employment contracts. The focus of the article is on post-termination restraints and the validity of restrictive clauses.

Introduction
Employers often impose restrictions on their employees. These restrictions are usually found in the employment contract, principally to prevent the concerned employee from damaging the business interests of the company. Some of the most common forms of restrictive clauses in employment contracts include non-competition clause, non-solicitation clause and confidentiality clause. The terms expressed in the restrictive covenants arise from the fundamental obligations of employees of good faith and fidelity towards their respective employers.

Broadly, restrictions may be categorised as those applying whilst the employment relationship continues and those that apply after the relationship comes to an end. While an employer can control the behaviour of an employee while the employment relationship continues, it cannot do so when this employee leaves the company. The employer can no longer monitor, much less regulate, his activities. Not being able to monitor or regulate the employee's activities poses a great threat to the former employer especially when the employee joins a competitor. These are some of the major considerations why restrictive clauses are incorporated into the employment contract. Without the confidentiality clause, for example, confidential information and trade secrets of the former employer may be divulged to the new employer to the detriment of the previous company. Additionally, key employees might be poached by a previous employee and might be convinced to join a competing firm if a non-solicitation clause is omitted from the employment contract.

This article discusses the two most common but very significant restrictive clauses in the employment context, namely, restrictive clause and confidentiality clause. It must be noted that a confidentiality clause is sometimes subsumed or incorporated into the restrictive clause of an employment contract. This article essentially focuses on post-termination restraints, although confidentiality clauses can be enforced while the employment relationship still subsists. A discussion on the validity of a restrictive clause follows. As will be presented below, the validity of a restrictive covenant depends on its reasonableness as between the
contracting parties and reasonableness in so far as the public interest is concerned.

Restrictive Covenants
A restraint of trade clause has been defined in Petrofina (Great Britain) Ltd v Martin [1966] Ch 146 and Esso Petroleum Co Ltd v Harper's Garage (Stourport) Ltd [1968] AC 269 ('Esso') as 'one in which a party (the covenantor) agrees with any other party (the covenantee) to restrict his liberty in the future to carry on trade with other persons not parties to the contract in such a manner as he chooses'.

Employers include a non-solicitation clause in their employment contract to prohibit a former employee from soliciting the employment of a director, officer or employee within a prescribed period. Often incorporated into the non-solicitation clause, although sometimes provided in a separate section of an employment contract, is a non-compete clause whereby employees are prohibited, for a certain period of time and within a set geographical location, from being employed by a competitor. These types of covenant are intended to prevent employers from losing their workforce to a competing firm.

Employers also seek to impose on their employees the obligation of confidentiality whereby the latter are prohibited from disclosing confidential information and trade secrets to a third party for a certain period of time. Although it is not always the case, the duty of confidentiality is frequently tied to the obligations mandated by the non-solicitation and/or non-compete clause.

Needless to say, the framework within which the restrictive covenants operate is an interplay of the following legitimate but conflicting interests:
1 the expectation of the employer that the knowledge and skills which have been imparted to or acquired by its employee during the course of its employment are not subsequently used by that employee to the employer's detriment following termination;

2 the right of a former employee to use and exploit the skill, experience and knowledge acquired by him during the term of employment to make a living and to advance his chosen trade or profession; and

3 the interest of the Government in securing an environment in which freedom of trade and competition can flourish.

In Singapore, the Courts have attempted to reconcile these legitimate but conflicting interests in the various decisions they have rendered. While the Courts evaluate each case based on its factual matrix, the common thread has been that restrictive covenants, to be valid, must be reasonable in respect to the interests of the parties and in respect to the interests of the public.

Validity of Restrictive Covenants
The seminal case of Thorsten Nordenfelt v The Maxim Nordenfelt Guns and Ammunition Company, Limited [1894] AC 535 provided the cornerstone of the principles relating to restraint of trade. Lord Macnaghten in this case observed that:

All interference with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy, and therefore void. That is the general rule. But there are exceptions: restraints of trade … may be justified by the special circumstances of a particular case. It is sufficient justification, and indeed the only justification, if the restriction is reasonable - reasonable, that is, in reference to the interests of the parties concerned and reasonable in reference to the interests of the public, so framed and so guarded as to afford adequate protection to the party in whose favour it is imposed, while at the same time … [being] in no way injurious to the public. [emphasis added]

Reasonableness is a reflection of the tension between the need to maintain the contracting parties' autonomy (ie freedom of contract) and the wider need to protect the public interest. Although the contracting parties are free to stipulate the terms and conditions of their agreement, they must likewise ensure that the interest of the public is protected or advanced. As will be discussed below, even if the Courts find that a restraint of trade clause is reasonable as between the parties, they may invalidate the same on the ground that it is against public policy.

Reasonable with respect to the interests of the parties
There are two main points that the employers must keep in mind in determining whether the agreement is reasonable vis-à-vis the contracting parties. First, there must always be a legitimate proprietary interest to protect that would warrant the Court's protection by way of the restraint of trade doctrine. Second, the agreement must not be wider than is necessary to protect the interest concerned. What this means is that even where a legitimate proprietary interest is shown, the employer must ensure that the covenant in restraint of trade goes no further than what is necessary to protect the interest.

Legitimate proprietary interest
It has long been established that there cannot be a bare and blatant restriction of the freedom to trade. As the Singapore Court of Appeal ruled in Man Financial (S) Pte Ltd (formerly known as E D & F Man International (S) Pte Ltd) v Wong Bark Chuan David [2008] 1 SLR 663 ('Man Financial'), there must always be a legitimate proprietary interest to protect that would warrant the Court's protection by way of the restraint of trade doctrine. The Courts will protect this proprietary interest even where there is no express covenant to this effect.

(a) Maintaining a stable workforce
In the employment context, there are several main interests which have been identified by the Courts as meriting protection. One of the more important interests that employers seek to protect in the employment context is that which relates to maintaining a stable workforce.

In Man Financial, the Singapore Court of Appeal held that the non-solicitation clause in the former employee's Termination Agreement was valid. Citing Legatt LJ's statement in Ingham v ABC Contract Services Ltd (English Court of Appeal, 12 November 1993, unreported) ('Ingham'), the Court explained that a non-solicitation covenant is intended to prevent an employee from poaching the employer's employees after he had left the company's employment. This is especially true in what is acknowledged to be a highly competitive business. Legatt LJ's statement of principle in Ingham is consistent with yet another English High Court decision, SBJ Stephenson Limited v Keith Anthony Mandy [2000] FSR 286. The Ingham principle has also been endorsed in a number of subsequent cases, including TSC Europe (UK) Ltd v Massey [1999] IRLR 22.

The Court in Man Financial noted that the former employee, by virtue of his position (ie managing director and chief executive officer) and influence while in the employ of the previous employer, possessed and utilised confidential knowledge gained in the course of his employment. Given the nature of the employer's business (ie brokerage company), the former employee could easily solicit employment from amongst the company's employees. Thus, the Court ruled that maintaining a stable and trained workforce is a legitimate proprietary interest that may be protected through a restraint of trade clause.

In the Australian case of Smith v Nomad Modular Building Pty Ltd [2007] WASCA 169, the non-competition clause in the former employee's employment contract prohibited him from engaging in a competing business in the restraint area of Western Australia and Queensland during six months from termination. The Western Australia Supreme Court of Appeal upheld the reasonableness of the restraint of trade. The Court observed that as a result of the resources boom in Western Australia, demand for senior staff in the industry exceeded supply. It was, therefore, difficult to replace a senior staff like the former employee, which undertaking might even necessitate months of training prior to the commencement of actual work of the replacement. According to the Court, the cumulative effect of a senior staff leaving the company would be disruption to the company's business, impairment of the efficient and timely performance of its contractual obligations and the consequent detriment to the goodwill of its business. The detriment to the goodwill of the company would then be exacerbated by the senior employee going to a competitor who would exploit this period of instability in the company's business.

(b) Protection of confidential information and trade secrets
Another proprietary interest which a Court will allow to be protected is that which relates to the confidential information and trade secrets of the employer. An employee is subject to a general duty of fidelity and confidentiality, the effect of which is to require him to keep the affairs of his employer secret both during and after his employment. During employment, the duty of confidentiality is usually construed more widely. After the termination of employment, however, the duty extends only to information which is strictly confidential and in the nature of a trade secret.

In Stratech Systems v Nyam Chiu Shin [2005] SGCA 17 ('Stratech'), the Singapore Court of Appeal stressed that the claim for protection of confidential information and trade secrets must be based on the identification of some advantage or asset which can properly be regarded as the employer's property, and which it would be unjust to allow the former employee to appropriate for his own purposes.

It was highlighted in Man Financial that a line must be drawn between a covenant which seeks to protect a legitimate proprietary interest on the one hand and one which merely seeks to prevent the employee from exercising his own natural skill and talent, even if such skill and talent are acquired by the employee in the course of his employment. As aptly stated in Stratech, the protection cannot be legitimately claimed in respect of the skill, experience, know-how and general knowledge acquired by an employee as part of his job during his employment, even though that may equip him as a competitor, or potential employee of a competitor, of the employer.

In the recent case of Helmet Integrated Systems v Mitchell Tunnard & Ors [2006] EWCA Civ 1735, the English Court of Appeal ruled that preparation to compete with a current employer did not constitute breach of the subject restrictive clause. The company in this case manufactured and sold firefighters' helmets. While still in the employ of the company, the former employee hit upon an idea for a new modular helmet, primarily, but not exclusively, for firefighters. Upon his resignation from the company, the former employee incorporated another company and continued to work on his new idea. The Court held that the former employee's job specification did not restrict his freedom to prepare for competition on leaving. It was held that he was entitled to take preparatory steps prior to leaving in order to assess the viability of any competitive activity once he had left, or whether it was sensible for him to leave at all.

The English Court of Appeal in Faccenda Chicken Ltd v Fowler [1987] Ch 117 set out guidelines that would aid the Court in ascertaining whether or not something constitutes a trade secret. According to the Court, it would be necessary to consider the following factors:
1 The nature of the employment - where the employee habitually handles confidential information a higher obligation of confidentiality may be imposed.

2 The nature of the information itself - only trade secrets or information of such a high degree of confidentiality as to amount to a trade secret would be capable of protection.

3 Whether the employer impressed on the employee the confidentiality of the information - it is insufficient for the employer to merely tell the employee that the information is confidential; the employer's attitude towards the information itself had to be considered as well.

4 Whether the relevant information can be easily isolated from other information which the employee is free to disclose - where the information alleged to be confidential is 'part of a package' and the remainder of the package is not confidential, this factor, although not conclusive in itself, can shed light on whether the information in question is truly a trade secret.

In Heller Factoring (Singapore) Ltd v Ng Tong Yang [1998] 3 SLR 299 ('Heller'), a restrictive covenant against seeking employment for two years with competitors offering factoring services was upheld against a former employee. In this case, the former employee had been trained to use and access the employer's computer system which was developed in-house by the employer over a period of two years and into which development a great deal of time and effort had been spent. The system was a custom-made programme and incorporated all of the employer's experience and knowledge of factoring operations accumulated over a 16-year period. As the employee was a credit and marketing executive, he had access to the confidential information relating to the clients. The nature of the information in question in that case no doubt strengthened the employer's case that it was confidential information which justified protection.

Contrast this case with HRnet One Pte Ltd v Choo Wai Ying Adrian [2006] SGDC 202, where the Singapore District Court held that the company's search process culminating in its extensive reports did not come close to being a trade secret. The Court observed that the search process employed by the company, including conducting extensive reference checks and verifying the candidates' remuneration details, were common to other recruitment consultancies. According to the Court, this process employed by the company in searching for a candidate was not confidential. Thus, it was not a legitimate interest that deserved protection by the restraint of trade clause in the former employee's contract.

No wider than is reasonably necessary
Assuming that there is a legitimate interest to protect, the English High Court in Allied Dunbar (Frank Weisinger) Ltd v Weisinger [1988] IRLR 60 stressed that the employer must only impose a restriction which is reasonably necessary to protect that interest. This was reiterated in a line of cases decided by the same Court, including TFS Derivatives Ltd v Morgan [2005] IRLR 246, where it was held that a restrictive clause must not be wider than is reasonably necessary for the protection of the employer's interest. To ascertain whether the clause as drafted is no wider that is reasonably necessary to protect the legitimate interest of the employer, the following factors are important.

(a) Period of restraint
To be reasonable, the period of the restraint should not exceed the period that is necessary for the protection of the legitimate interests of the employer. In the English case of M & S Drapers v Reynolds [1957] 1 WLR 9, a period of five years imposed upon a collector salesman was held to be too long and thus unreasonable. Contrast this with the ruling of the Singapore High Court in Heller where it was held that the two-year restriction imposed on the former employee not to be employed with a competitor in the whole of Singapore was reasonable in the context of the factoring industry.

(b) Geographical area
The rule with regard to the geographical area of a restrictive clause is that the area should be co-extensive with the protection of the legitimate interests of the employer. In Buckman Laboratories (Asia) Pte Ltd v Lee Wei Hoong [1999] 3 SLR 333, the former employee was prohibited within one year from the termination of his employment from working in connection with the development, manufacture and sale of any of his employer's competitive product/service in Southeast Asia and other countries such as Kampuchea, Laos, Afghanistan, Iran, Saudi Arabia, Kuwait, Qatar, United Emirates and Oman. The Singapore High Court ruled that the restrictive clause effectively prevented the former employee from working for any competitor company in most of Asia. On the facts, the former employer did not directly assert that it had customers in those countries enumerated above. The management merely stated that the company was trying to 'establish a permanent presence' in the same. Given this, the Court held that what the employer was trying to protect was its potential business rather than its actual business in those countries. The Court then commented that a 'more reasonable clause would have limited restriction to countries which [the former employer] had actual and significant customer contract'.

(c) Scope of activities prohibited
A restraint in trade clause cannot be reasonable unless it is confined to protecting the legitimate interest of the employer. The English Court of Appeal in Commercial Plastics Ltd v Vincent [1964] 3 All ER 546 declared the restriction imposed on the former employee void and unenforceable because the restrictive clause was wider than was reasonably necessary under the circumstances of the case. It was observed by the Court in this case that what the company only needed was protection for trade secrets or confidential information relating to the production of calendared sheeting for adhesive tapes. The subject restrictive clause, however, extended to the entire field of calendared sheeting.

In SeaCAD Technologies Pte Ltd v Kok Kean Wei [2004] SGDC 179, the Singapore District Court examined the list of things in the employment agreement of the company which were classified as confidential information. The company was engaged in the sale of a Computer Aided Design ('CAD') software. The list included 'any idea, improvement, invention, innovation, development, technical data and computer program … for a new or revised product …'. It was found that the list was extremely wide and went beyond what could be legitimately protected.
In the recent English case, Thomas v Farr plc [2007] EWCA Civ 118, a clause in the former employee's employment contract prohibited him from competing with the company for 12 months after the termination of his employment. The Court held that there was ample evidence to support the conclusion that in the nature of things, the former employee's appointment as the company's managing director exposed him to relevant information which the company was entitled to protect after the employee's termination of employment. The non-competition clause was thus reasonable and enforceable.

Reasonable with respect to the interests of the public
It is not sufficient that a restrictive covenant is reasonable as between the parties. It must also be reasonable with respect to the interests of the public. Lord Pearce in Esso asked this very important question to highlight this point:

There is one broad question: is it in the interests of the community that this restraint should, as between the parties, be held reasonable and enforceable?

The landmark Singapore High Court decision of Thomas Cowan & Co Ltd v Orme [1961] MLJ 41 ('Thomas Cowan') is worth noting in this regard. In Thomas Cowan, the employer brought an action against its former employee to restrain him from continuing to commit a breach of his employment agreement relating to the employer's fumigation business. The agreement in question prohibited the former employee from carrying on a fumigation business anywhere in Singapore or from taking employment with any person carrying on the business of fumigation within three years from termination of employment. The Court first considered the agreement as being reasonable with respect to the contracting parties. However, it held that it was detrimental to the community at large since it created a virtual monopoly of fumigation work in Singapore on the part of the employer. According to the Court, it is contrary to the public interest that the employer should, by the agreement, be able to monopolise fumigation work in Singapore. In particular, the Court observed thus:

It is clear that if the defendant is not allowed to operate the plaintiffs would have a virtual monopoly in Singapore as regards fumigation by hydrogen cyanide and methyl bromide. In fact prior to the defendant's firm coming into existence the plaintiffs were the only firm in Singapore doing fumigation. ... [S]ince the defendant's firm commenced business in competition with the plaintiffs, the charges for ship fumigation have dropped, which is a good thing ... [emphasis added]
The principle laid down in Thomas Cowan (ie the interests of the public should also be satisfied) was endorsed in the subsequent cases of Nature's Farm & Ors v Poa Kheng Bee & Ors (unreported), Tang Siew Choy v Certact Pte Ltd [1993] 3 SLR 44 and, recently, Man Financial.

Concluding Words
A restrictive covenant is not valid unless it is reasonable as a matter of both private and public interests. There must be a legitimate proprietary interest that the employer seeks to protect in imposing a restrictive covenant. Moreover, the restriction must not be wider than is reasonably necessary to protect the interest.

Indeed, the approach of determining the validity of a restrictive covenant in terms of its reasonableness as between the parties and in relation to the interests of the public is appropriate, as it is not only valuable to the contracting parties, but also desirable to the interests of the public. This is so because the community at large, and not only the contracting parties, should not be denied the fruits of competition.

Hazel Galimba Guiling
Kala Anandarajah
Rajah & Tann LLP
E-mail: hazel.guiling@rajahtann.com
E-mail: kala.anandarajah@rajahtann.com