Claiming damages for breach of post termination restrictive covenants

by Hong Tran, senior associate, Employment and Employee Benefits Group, Johnson Stokes & Master

Article exclusively contributed by Johnson Stokes & Master

In October 2003, a number of employees left property agency Eastford (China) Ltd. They started work with Primacy Properties Ltd, which is located less than 150 metres from Eastford's offices.

One of these employees, a Mr Cheung, while employed by Eastford, worked as a salesperson in the Yuen Long and Tuen Mun districts. His contract of employment with Eastford contained a restrictive covenant which provided that: "Within 12 months of cessation of employment, the employee should not work as a property agent or engage in any related work in the same working area". "Working area" was defined as the Yuen Long and Tuen Mun districts.

Eastford alleged that after Mr Cheung left, he solicited business and orders from their customers and enticed staff away, causing Eastford to suffer a significant reduction in income.

In February 2004, Eastford applied for an injunction restraining Mr Cheung from such actions for the stipulated 12 months following his departure. The High Court granted the injunction.

After the 12 months restraint period expired, Eastford claimed damages from Mr Cheung, advancing its claim solely on the basis that Mr Cheung had breached the post termination restrictive covenant.

Importantly, Eastford did not allege that Mr Cheung had breached his duties of fidelity and fiduciary duties to Eastford.

A factual issue that arose for consideration by the Court was whether Mr Cheung's contract of employment had been terminated by Eastford earlier and replaced with a contract not containing any restrictive covenant.

Mr Cheung alleged that in October 2003 a meeting was called by the directors of Eastford and that he and other employees were informed that following Eastford's restructuring, their employment terms would be changed. There would be no basic salary, no fixed working hours and the agents would be free to take up business for other agencies.

Mr Cheung's primary defence at trial was that as a result of that meeting, his contract of employment containing the restrictive covenants had been terminated by Eastford and had been replaced with a contract that did not contain such restrictive covenant.

Mr Cheung did not seek to argue in his defence that the restrictive covenant was unreasonably wide and therefore unenforceable. He accepted that if the contract with the restrictive covenant was found to exist, the restrictive covenant would be enforceable.

Mr Cheung further alleged that the idea to set up a new agency came up only after he had left Eastford.

Deputy High Court Judge Gill held that on evidence the contract with the restrictive covenant was still in existence at the time he resigned. There was no unilateral election by Eastford to terminate that contract and replace it with another that did not contain a restrictive covenant.

The judge was not convinced that a self-respecting agency would, immediately upon shareholding restructuring, put its workforce into an unstable position which would likely lead to their departure en masse. There were no apparent benefits with the alleged new arrangement and, in fact, the judge said that such cancellation of the contract of employment which included the restrictive covenant would be potentially damaging to Eastford.

Mr Cheung's version of events also did not fit the timetable required for the incorporation process of Primacy. The judge found that the discussions to set up Primacy were underway in early October, instead of after the termination of Mr Cheung's employment, as submitted by him.

Judge Gill found that Mr Cheung had breached the restrictive covenant in his contract of employment with Eastford and was therefore liable for any damages suffered by Eastford as a result.

Eastford had alleged that its income had been drastically reduced as a result of Mr Cheung's breach. On this point Judge Gill said, "the loss of significant business and income for the months following the mass departure of the workforce would have been almost inevitable given that property agents with ongoing transactions to put together are the lifeblood of the agency they work for."

However, this does not mean that business, and income, found its way to Primacy, and if it did that Mr Cheung had been responsible for this by unlawful means. Eastford was unable to prove that it had suffered any loss as a result of Mr Cheung's breach. Its claim for damages was therefore dismissed. Mr Cheung was awarded his costs from the date of expiry of the injunction in October 2004.

Q & A on post termination restrictive covenants
Q1 Are all post termination restrictive covenants enforceable?
A1 Generally post termination restrictive covenants are void as being in restraint of trade and contrary to public policy. They will only be enforceable if the employer can show that they are necessary to protect the employer's legitimate interests and if the clause goes no further than is reasonably necessary to protect those interests.

Q2 What legitimate interests may be protected by restrictive covenants?
A2 Legitimate business interests include trade connections and goodwill, trade secrets and other confidential information and maintaining a stable workforce.

Q3 How do you work out whether a restrictive covenant is reasonable?
A3 Consideration of whether a restrictive covenant is reasonable will usually be by reference to the period of restraint, the geographical scope of the restraint and the activities the employee is restrained from engaging in. The enforceability of a post termination restrictive covenant will turn on the surrounding facts and circumstances. A court will not rewrite restrictive covenant in order to make it enforceable. However, a court may be prepared to delete (or blue-pencil) words, provided the deletion does not change the overall character of what has been agreed to by the parties.

Taken from Career Times 27 October 2006

(Last review date: 23 August 2013)

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Disclaimer: The opinions expressed in this article are those of the contributor

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