Thank you for your consideration - as published in Tolleys Employment Law Newsletter

Employers often overlook the need to provide consideration to an employee who signs up to new restrictive covenants during employment. Failure to do so may have serious consequences because the restrictions will not bind the employee. 

Former employees accused of acting in breach of post-termination restrictive covenants will often cling to any arguments at their disposal in an effort to avoid applications for injunctions and claims for damages. Re-Use Collections v Sendall [2014] EWHC 3852 (QB) has recently given such employees a potential life line. The Court found that when an employer introduced new restrictions for an employee during his employment, valuable consideration had not been given to the employee in return for his signature. The covenants were therefore not valid. Following this case employers would be best advised to audit any restrictions that they have in place with existing employees in order to check that consideration was provided. Employers who are contemplating court action to enforce restrictive covenants should also be prepared for arguments from former employees that they are not bound by their covenants, even though they signed up to them in writing without a murmur of discontent. 

Creating a legally binding contract 

In order for a legally binding contract to be formed, there must be an offer, acceptance of that offer, consideration and an intention to be legally bound by its terms. The legal concept of consideration is based on the premise that a contractual promise will only be enforced if the person benefiting from it has provided something in return. Generally the courts are not concerned with the adequacy of consideration provided, although it does have to have some value (but this does not have to be monetary value). However, when it comes to post-termination restrictions, courts are often prepared to consider arguments about whether the consideration provided by the employer is adequate. 

Specific consideration required

Mr Sendall worked for a family recycling business. When the business was sold in the 1990s, he remained employed as a depot manager. At this point he had no written employment contract. In October 2012 he was given a draft employment contract which for the first time contained express confidentiality obligations and post-termination restrictions, including a non-compete provision. Although initially reluctant to do so, he eventually signed the contract in February 2013 after taking legal advice. This is somewhat surprising because as soon as the next month, in March 2013, he gave three months’ notice of his resignation in order to work for a competing business run by his sons. The company sought an injunction to enforce the post-termination restrictions.

Mr Sendall argued that the restrictions were not binding on him because the company had not provided any consideration for his agreement to the restrictions. He argued that where an employer seeks to impose substantial new obligations on an existing employee, the consideration must comprise “some real monetary or other benefit (a promotion, for example) conferred on the employee for the purpose of causing the employee to agree the restrictive covenant” and it must be “substantial and not nominal”. The Court appeared to accept this argument.

The company accepted that consideration was required, but contended that it had provided consideration:

• since the covenants were introduced as part of a package which conferred benefits on Mr Sendall, including a pay rise; or
• by continuing to employ him in the months after the contract was produced.

The High Court was not convinced. The company had not provided any consideration for the covenants. The new contract predominantly confirmed Mr Sendall’s existing entitlements. Although Mr Sendall’s life assurance benefits had been increased (from 2 x salary to 4 x salary) there was no evidence of a connection between this enhancement and his agreeing to the new restrictions. In addition, although Mr Sendall was given a pay rise, there was insufficient evidence that:

• it was specific to him (or to his colleagues who were being asked to enter into formal employment contracts);
• it was made clear to him that it was conditional upon him signing the contract. In fact it was not referred to in the contract (which referred to the old salary) and it took effect in January 2013 even though he had not signed the contract at that point; or
• in some more general sense, it was linked to the introduction of the new employment contract.

In addition, the Court commented that continued employment was not sufficient in a case such as this where a long-serving employee is being asked to accept new, substantial contractual restrictions. There was no evidence to suggest that had Mr Sendall declined to sign up to the restrictions, the company would have terminated his employment or that some lesser sanction would have been imposed. Consequently, it could not be said that the company provided consideration merely by continuing to employ him, without seeking to link its continued willingness to employ him with his willingness to sign the contract. 

Implications 

Employers might be forgiven for thinking that once they have a signed employment contract in their possession, any post-termination restrictions will be binding, subject to the usual hurdles of identifying a legitimate business interest which they are seeking to protect (such as goodwill or trade secrets) and ensuring they are reasonable i.e. they go no further than is necessary to protect their legitimate business interest. 

However, contracts will only be legally binding if consideration has been provided and the same applies when it comes to making contractual changes - the employer needs to provide consideration in return for the employee’s agreement to the change. The Court appeared to accept that it is a well-established principle that where an employer seeks to impose substantial new obligations on an employee, the consideration must be substantial and not nominal. It observed that this applies not just to post-termination restrictions, but also to new confidentiality obligations, particularly if they impose substantial new obligations on an employee. 

Continued employment?

Where employment contracts contain post-termination restrictions when an employee joins, the employer provides consideration by agreeing to employ the employee and paying his salary and benefits. However, if new restrictions are introduced during employment, continued employment will not be sufficient of itself. This is equally the case if existing restrictions are amended during employment. The employer is only agreeing to do what he is already contractually obliged to do (employing the employee). Therefore the employer is not giving anything additional in return for the employee’s agreement to the restrictions. As the Court points out in this case, an indication from the employer that refusal by the employee to sign will result in the termination of employment may result in continued employment providing consideration.

However, in practice employers are unlikely to want to make such a draconian threat and any subsequent dismissal could give rise to an unfair dismissal claim. In addition, if large numbers are involved, collective redundancy consultation obligations could be triggered. This could also be self-defeating as it carries with it the risk that the employee (who presumably will not have any valid post-termination restrictions) will realise that they are free to go and work for a competitor and potentially take clients and employees with them. 

What are the other options?

Employers seeking to introduce new post-termination restrictions are best advised to link the changes to a pay increase or the award of a bonus. When introducing the changes, they should make it clear that receipt of the pay increase or the bonus is conditional upon the employee agreeing to the new restrictions. They should also make sure that this is what happens – it is no good telling the employee that he will not receive a pay rise or bonus if he does not sign up to the new terms, and then giving it to him anyway, before pen is put to paper. 

Another option is to introduce the restrictions at the time of an employee’s promotion. This is in any event a good time to review and amend existing covenants to make sure that they are appropriate for the new role. In this regard, the High Court’s decision in Patsystems Holdings Limited v Neilly [2012] EWHC 2609 (QB) is important. There the Court ruled that restrictions in a senior salesman’s contract which were void and unenforceable when he entered into them many year previously (when he was a junior), could not be resurrected and turned into valid ones, simply by the salesman signing a letter upon accepting the promotion agreeing that all other terms remained unchanged. The employee should instead be asked to sign a new contract containing valid covenants; a mere acknowledgment is insufficient.

What about a deed?

Normally signing a document as a deed removes the need for consideration. However, this is unlikely to be sufficient where it contains post-termination restrictions or confidentiality obligations. The need for consideration to be substantial, rather than nominal, suggests that this is not going to work. In fact, there is case law from as long ago as 1839 (Hutton v Parker (1839) 7 Dowl 739) that suggests that nominal consideration will not be sufficient in the case of post-termination restrictions. 

What about restrictions agreed on termination?

Employers will often seek to agree new restrictions with a departing employee when agreeing settlement terms. Again valuable consideration will be required. Employers should consider allocating a specific sum to the agreement to enter into the restrictions, or ensure they give some other valuable consideration. This is also recommended for tax reasons. Payments made for entering into restrictive covenants are subject to income tax and National Insurance Contributions. If a specific sum has not been allocated to the restrictive covenants, HMRC may argue that the whole termination payment is consideration for the covenants and should be taxable in full. 

Is the value of consideration relevant to reasonableness of covenant?

Restrictive covenants are only enforceable if they are reasonable i.e. if they go no further than is necessary to protect the employer’s legitimate business interests. A question which is often debated is whether the value of the consideration provided has any bearing on this separate question of whether the covenants are reasonable. Although the Court did not hear full argument on the point (and it was unnecessary for it to decide it in view of its finding that no consideration was provided in this case) it did say that if it had to decide the point it would consider that the adequacy of the consideration provided by the employer is relevant to the reasonableness of the restrictive covenant. This is therefore a further reason why signing a document as a deed, or providing other nominal consideration, is not going to be sufficient when it comes to agreeing post-termination restrictions with existing employees.

This Article, written by Peter De Maria, was originally published in Tolleys Employment Law Newsletter.