How can law firms protect their interests when a key lawyer leaves? David Fisher looks at current law & practice on restrictive covenants
- Looks at scope of restrictive covenants against lawyers.
- Considers how courts would treat Bridge v Deacons today.
Like any other type of business, law firms need protection when key individuals leave to join a competitor. Most firms—but by no means all—include post-termination restrictive covenants in their partnership agreements and employment contracts, but they have to be drafted carefully and used appropriately, otherwise they are likely to be unenforceable.
The basic starting position is that restrictive covenants are void on grounds of public policy as they are in restraint of trade, but the law will allow them provided:
- They are necessary to protect one or more of the firm’s ‘legitimate business interests’, which normally means its trade secrets or confidential information, its client or supplier connections, or the stability of its workforce; and
- They go no further than is reasonably necessary between the parties to protect those interests.
A common misconception is that restrictive covenants can be used merely to prevent competition—they can’t, as that is not a legitimate business interest, but in some cases the courts recognise that the only way a business can effectively protect its legitimate interests is to stop the individual who leaves from working in competition with the business for a limited period of time and/or within a defined geographic area. This type of covenant is generally known as a ‘non-compete’ restriction, and such a covenant may be permitted where less onerous restrictions (such as those which prohibit the misuse of trade secrets and confidential information, and prevent the former partner or employee from soliciting or dealing with particular clients for a limited period) will be insufficient as they cannot be policed effectively for some reason.
One issue that surprises many partners who are looking to move between firms (and, it has to be said, many employment lawyers who do not also specialise in partnership work) is the broad reach of partners’ restrictive covenants, especially when compared with the restrictions normally imposed on employees—and this is the case whether it is a traditional partnership (under the Partnership Act 1890) where the individual is truly a ‘partner’, or a limited liability partnership (LLP) as so many law firms now are, where individuals are given the title of ‘partner’ but in fact have the legal status of a ‘member’. Where an individual is a ‘salaried partner’ however (ie he or she is paid a salary rather than a share of the firm’s profits), then, generally speaking, he or she ought to have an employment contract and be treated as an employee for the purposes of any restrictive covenants.
Take a typical ‘non-solicitation’ covenant, for example. Where an employee has contact with the firm’s clients in the course of his or her work, or has access to confidential information relating to its clients, the firm might want to protect its client relationships and confidential information and prohibit the employee from trying to solicit or obtain business from those clients if he or she leaves to join a competing practice. The firm might want to go a step further and also include a ‘non-dealing’ covenant in the employee’s contract of employment, which will prohibit the employee from having any competitive business dealings with the clients, regardless of whether it is the employee or the client who approaches the other about continuing their business relationship.
Both of these covenants are intended to protect the firm’s legitimate business interests, but to be enforceable their scope must be limited in such a way that they are not unnecessarily restrictive towards the employee.
This means, first, that the restrictions should last no longer than they really need to—so if the firm ought to be able to consolidate or build up new relationships with the clients within six months, and the shelf life of the confidential information which is available to the employee is also about six months, then non-solicitation and non-dealing covenants which last for 12 months are likely to be unenforceable.
“Where disputes do develop into legal proceedings, they are often subject to arbitration & never become public knowledge”
Second, the restrictions should ideally only relate to clients with whom the employee had material contact in the course of working for the firm during a limited period before leaving, or about whom he or she had confidential information. If the restrictions attempt to cover all of the firm’s clients, regardless of the employee’s previous dealings with them, then they are likely to be too wide and therefore unenforceable.
However, the courts have developed a different approach to equity partners in a firm, underpinned by the Privy Council’s decision in Bridge v Deacons AC 705. Mr Bridge was an equity partner in Deacons, a law firm in Hong Kong. He was head of the IP and Trade Mark department, which dealt with about 10% of the firm’s clients and generated about 4.5% of its turnover. He had no dealings with, and little exposure to, clients of the firm’s other departments. Under the firm’s partnership agreement Mr Bridge was entitled to 5% of the firm’s business and assets (including goodwill, which was given a nominal value in the agreement), and when he left to set up his own practice he received a substantial payment for his partnership share (but only a nominal amount for his share of the goodwill).
The Deacons partnership agreement contained a restrictive covenant which prevented Mr Bridge from acting as a solicitor in Hong Kong for five years for any client of the firm or any person who had been a client of the firm during the three years before he left—although this did not apply if he went to work in-house or for the government. The restriction was not confined just to clients with whom Mr Bridge had dealt while at Deacons. Notwithstanding this restrictive covenant, Mr Bridge began acting for former clients of Deacons, and Deacons applied successfully for an injunction to restrain him from doing so.
The arguments which Mr Bridge used to oppose the injunction were unsurprising:
- The scope of the restrictive covenant was too wide, as it prevented him from acting for 90% of the firm’s clients with whom he had had no connection or dealings.
- The five-year duration of the covenant was too long.
- As he had only received a nominal amount for goodwill, the firm was not entitled to protect it by way of the restrictive covenant.
Bridge v Deacons decision
However, the Judicial Committee of the Privy Council decided that the restrictive covenant was reasonable and therefore enforceable. In its view:
- Although divided along department lines, Deacons was a single practice in which all of the partners had an interest, owned all of the assets and shared the profits and losses according to their respective profit sharing ratios.
- The firm was entitled to protect its legitimate interests by imposing a restrictive covenant on outgoing partners and, having regard to the value of the firm’s business and Mr Bridge’s position as an equity partner, the scope and duration of the covenant were not unreasonable.
- Every partner was bound by the restrictive covenant and benefited from it in relation to the activities of his fellow partners.
- Mr Bridge had had the benefit of the firm’s goodwill while he had been a partner, and the firm now wished to protect it. This protection was in the public interest as it secured the continuity of solicitors’ practices, which would be of benefit to clients, and would ‘encourage the entry of younger men into the profession’ by making partnership available to them without requiring payment of the full market value of their share in the goodwill, which they probably could not afford. It was irrelevant that only a nominal sum had been paid for goodwill, as the transfer of Mr Bridge’s share in it was not a cash sale but was in accordance with the partnership agreement, under which Mr Bridge was only charged a nominal amount for goodwill when he became an equity partner in the firm.
- The partners had equal bargaining power when entering into the partnership agreement and were therefore to be regarded as the best judges of what was reasonable in a commercial bargain. The fact that the partners concerned were lawyers was also a relevant consideration.
What would happen today?
Relying on Bridge v Deacons , it is still common in 2018 for partners and LLP members to be subject to restrictive covenants which apply to all of a firm’s current or recent clients, and which last for up to two years from the point of departure or even longer—covenants which no one would now think of including in an employment contract.
Are such broad restrictions likely to be enforceable, or would a court now take a very different view? Many of the factors taken into account by the Privy Council in reaching its decision in Bridge v Deacons will still apply to partners in traditional partnerships and members of LLPs today—such as the holding of a joint interest in the business and the sharing of its profits and losses, and the mutual nature of the restrictive covenants. But as firms have grown in size and their management structures have evolved, it is surely harder to say that there is real equality of bargaining power for someone who is joining a firm and is required to adhere to the restrictive covenants in its existing partnership agreement, or that it is reasonable to prevent a departing partner from soliciting or dealing with clients with whom they have never had any connection, just because one of the other several hundred partners in the firm has.
The fact that there hasn’t been another leading authority in this area in the past 35 years is no doubt largely due to a reluctance on the part of law firms, and the partners involved, to litigate cases involving their clients. Most disputes will be resolved by negotiation and a commercial deal between the parties, especially where the firm seeking to enforce non-dealing restrictions in relation to particular clients wants to retain the clients’ instructions in other practice areas and therefore can’t afford to upset them. Where disputes do develop into legal proceedings, they are often subject to arbitration and will never become public knowledge.
It could well be some time before these issues are tested again before the appellate courts. Until then, cautious drafters of partner restrictive covenants might be inclined to approach them more narrowly, as if they were employment restrictions, while those seeking to enforce existing broad partner covenants can still negotiate from a position of some strength in the knowledge that the law, as it stands, is still on their side.
David Fisher, published in New Law Journal.