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How to Protect Your Firm’s Goodwill with Partner Restrictive Covenants – The Key Building Blocks of an LLP Agreement: Part 3

It is crucial that firms safeguard the goodwill in their business following a partner’s departure, by ensuring that any retiring partner restrictive covenants are enforceable as far as possible.

The Privy Council decision in Bridge v Deacons [1984] 2 All ER 19 remains the leading authority on the enforceability of restrictive covenants against partners. In Bridge v Deacons, a five-year client non-dealing clause in the partnership agreement preventing former partners from acting for any client of the firm of the 3 years preceding the partner’s exit, was found to be enforceable.

Many commentators have expressed the view over the years that such a partner non-dealing covenant, if viewed now or in the context of LLP members, would be unlikely to be upheld. Nevertheless, the principles set out in Bridge v Deacons were applied to an LLP member against whom an interim injunction was sought and obtained, in the more recent decision in PricewaterhouseCoopers LLP v Carmichael [2019] EWHC 824 (Comm). There still nevertheless remains room for debate on the enforceability of partner and LLP covenants, and it is important to regularly review your firm’s partner or member restrictive covenants to ensure they are tailored and up to date to reflect the business, its current structure and reach. Please see below for further details.

You can also find out more about our firm’s market-leading partnership law expertise in our new Partnership Services Brochure here.

Partner Covenants – A Brief Reminder 

In order for any restrictive covenants to be enforceable against a former partner, the firm will need to establish that the covenants in the Partnership or LLP Agreement are sufficiently limited so that they are no more than reasonable and necessary to protect the firm’s legitimate business interests. If the covenants are too wide, they run the risk of being unenforceable.

When reviewing each of your covenants and their enforceability, the three key aspects to consider are (i) duration (if it is too long it could be deemed unenforceable), (ii) type of restriction (some are more difficult to enforce than others) and (iii) scope (including but not limited to business and geographic scope – if the scope is too wide it could also be unenforceable).

Duration

When settling on the duration of any covenants, a firm will need to demonstrate that the period is reasonable and necessary to protect its legitimate business interests, for example to allow it sufficient time to protect confidential information of the firm and to consolidate client and staff relationships in the wake of a partner’s departure.

Typical restriction periods for professional services firms range from six months to up to two years (the latter being less common) (five-year restrictions as in Bridge v Deacons are relatively unheard of these days, except in exceptional cases).

Where there are two or more classes of partners in a firm, a shorter period is commonly applied to the junior tier(s) (e.g., six months) whilst a longer period is applied to senior partners (e.g., 12 months).

A firm may also wish to consider whether any period spent on garden leave should be deducted from the restriction period so that a partner is only locked out of the market for a maximum period of (for example) 12 months (which would include both his/her garden leave and restrictive covenant period).

Types of restrictions

Most professional services firms’ Partnership and LLP Agreements include “non-solicitation” covenants preventing a former partner from poaching certain clients, staff and introducers. These are normally limited to categories of individuals with whom the partner worked closely or in relation to whom they had particular influence during a period of commonly 12-24 months prior to the partner’s departure.

It is increasingly common to also include “non-dealing” covenants preventing a partner from acting for a client (even if the client approaches him/her) or employing/going into business with staff or other partners (regardless of whether the relevant employees or other partners were encouraged to leave the firm).

Non-compete covenants are relatively unusual in the professional services sector (although more common in some professions such as financial services and accountancy) and the most likely to be challenged as unenforceable. If you do have a non-compete covenant in your LLP Agreement you should consider whether it should be for a shorter duration than the non-solicitation/non-dealing covenants and whether it is sufficiently narrow in scope (see below) in order to maximise the likelihood of the covenant being enforceable.

Professional services firms are increasingly using sophisticated covenants which seek to prevent team moves by partners and employees. Whilst such provisions are yet to be tested in court, a carefully drafted team move covenant can be a significant deterrent to partners contemplating a team move. Together with the duties which LLP members and partners owe whilst they remain a part of their firm, a team move prohibition could also place the firm in a much stronger position to seek injunctive relief as well as other legal redress, and to enable them to negotiate a commercial settlement with the departing partners and potentially also the firm they plan to join (who may be joined as a party in any High Court proceedings). They do however need to be drafted very carefully to fit the circumstances of the firm.

Scope of restrictions

The scope of the restrictions should be aligned with the size and nature of the firm’s business. If it is a relatively large firm with multiple offices in numerous locations/jurisdictions, covenants restricting a partner from soliciting or dealing with any client or employee of the firm may be deemed unreasonable. A similar restriction for a small single office firm would be more likely to be enforced.

Restrictions should be sufficiently narrow in scope, for example by reference to a specific geography (e.g. the area/jurisdiction in which the partner is based) and clients with whom a partner has had personal contact or access to confidential information. Similarly, non-solicitation of colleagues can be narrowed to specific categories of employees and those based within the partner’s team.

Common areas of challenge

Departing partners often challenge the enforceability of the restrictive covenants under their firm’s Partnership or LLP Agreement as a tactical stance when negotiating exit terms.

In addition to common challenges relating to overly wide drafting, lack of legitimate interest,  alleged unenforceable TUPE-related changes following an LLP merger (amongst others), they also often include arguments that the individual’s status is more akin to that of an employee than a partner or LLP member, and that their restrictive covenants should be viewed from a narrower employment law perspective and are thereby unenforceable.

The rule against dual partner/LLP and employee status – and how to determine the true status of an individual under the terms of their contractual agreement, was explored extensively in Reinhard v Ondra LLP [2015] (No 2), which considered that the correct approach “…. is to weigh all of the competing factors and to determine whether the contract creates an employment relationship or a membership relationship given that it cannot, because of section 4(4) [Limited Liability Partnership Act 2000], create both.”  A carefully drafted and properly construed LLP Agreement will usually present an uphill struggle for an individual to establish that overall, they are in reality employees – at least for contractual and restrictive covenant purposes (as opposed to statutory employment purposes), and not LLP Members who are properly bound by the restrictive covenants in that Agreement.

Some partners also seek to argue that their firm has committed a repudiatory breach which entitles the partner or LLP member to treat themselves as released from their partnership obligations, including their restrictive covenants. That argument however was effectively closed down by the decisions in Hurst v Bryk [2000] in respect of general partnerships and Flanagan v Liontrust [2015] in respect of LLPs, which cases concluded that the principle of repudiation does not apply to partnership and LLPs respectively (save perhaps in the context of a two person firm).

Keeping your covenants under regular review

To avoid being wrong-footed by challenges of potential unenforceability, it is important that you keep your covenants under regular review to ensure that they remain reasonable in the context of the firm’s business and in accordance with general market practice.

If you have any questions or would like advice regarding your LLP Agreement or any of the issues discussed above, please contact Zulon Begum or Clare Murray or call us on +44 (0) 207 933 9133.

CM Murray LLP is ranked in Tier 1 and Band 1 for Partnership Law in Legal 500 and Chambers & Partners, and is described as “One of the legal world’s strongest offerings in this area” (Legal 500).

To find out more about our partnership law expertise and our team of 18 specialist partnership and employment lawyers, please click here for our Partnership Services Brochure.

Read parts one and two of our ‘Key Building Blocks of an LLP Agreement’ series: Decision-Making and Management Structure in LLP Agreements and Securing Long-Term Stability of your Firm through your LLP Agreement.