How to lose a busi­ness — with­out lift­ing a finger

The share­hold­ers own the busi­ness, right? After all, they own the com­pa­ny, which pays the rent and the staff and the bills that keep the lights on and the pho­to­copi­er hum­ming. The cus­tomers are cus­tomers of the busi­ness, aren’t they? Sure, your employ­ees have the direct rela­tion­ship with the cus­tomers, but the cus­tomers belong to the business…don’t they?

Well, maybe not.

Let’s remem­ber that the real val­ue of many busi­ness­es lies in their rela­tion­ships with cus­tomers (rather than plant and equip­ment). In these busi­ness­es, it’s the peo­ple who own’ those cus­tomer rela­tion­ships who effec­tive­ly own the rev­enue – thus the busi­ness itself. If those key employ­ees are free to waltz off and take those rela­tion­ships with them (ie if they are not bound by post-employ­ment restraints) it’s ques­tion­able whether the com­pa­ny (prac­ti­cal­ly) owns any­thing, except pos­si­bly some stock in the ware­house. This is not just a the­o­ret­i­cal issue — we have been asked for advice by many employ­ers whose busi­ness­es have been destroyed when a key employ­ee has walked out of the door tak­ing the busi­ness’s cus­tomers with them — and leav­ing the employ­er with lit­tle but fixed costs and a rem­nant cus­tomer base bare­ly capa­ble of ser­vic­ing those costs. 

The sit­u­a­tion is sim­i­lar in many knowl­edge-based’ busi­ness­es – if an employ­ee with knowl­edge of key-process­es moves on and imme­di­ate­ly sets up in com­pe­ti­tion, the effects of this reverse Tro­jan horse’ may be dev­as­tat­ing for the for­mer employ­er’s business.

So if I am work­ing in a rela­tion­ship’ or knowl­edge’ busi­ness where the key staff are not bound by restraints, my job (and that of many oth­er employ­ees) could be a casu­al­ty if those staff leave and take cru­cial busi­ness rela­tion­ships and know-how with them. I’d say that’s a rea­son to care!

There’s noth­ing that can real­ly be done in prac­tice, right?’

For some rea­son, there’s an employ­ment law myth that post-employ­ment restraints are unen­force­able and that for­mer employ­ees are at lib­er­ty to go on to do what­ev­er they like – includ­ing tak­ing cus­tomers with them.

But the real­i­ty is dif­fer­ent. In fact, courts rou­tine­ly issue injunc­tions against ex-employ­ees lim­it­ing their activ­i­ties after ter­mi­na­tion – and busi­ness­es and their own­ers receive the pro­tec­tion they seek. For example:

A 12 month ban on approach­ing customers

A for­mer employ­ee of a labour hire com­pa­ny who had worked for a sin­gle client (the Queens­land Gov­ern­ment) for a num­ber of years was restrained from work­ing for the same client via anoth­er labour hire com­pa­ny. The employ­ee’s con­tract con­tained a com­mon­ly used non-solic­i­ta­tion clause pre­vent­ing the work­er from being able to solic­it, can­vas, deal with or approach any per­son… who… was pro­vid­ed with goods or ser­vices by… [the for­mer employ­er]” for 12 months after leav­ing. The restraint was upheld by the court.

Impor­tant­ly, there was noth­ing unusu­al about this deci­sion; rather it fol­lowed a long line of such deci­sions by courts where prop­er­ly draft­ed post-employ­ment claus­es are upheld. So busi­ness­es can pro­tect them­selves with effec­tive restraints which can be enforced for extend­ed peri­ods and in a mean­ing­ful way. 

Please Sir, Can I have some more?

A 6 or 12 month restraint is not unusu­al – but the courts sel­dom enforce employ­ment con­tract restraints for a peri­od longer than 12 months. Usu­al­ly, the restraint is lim­it­ed to not-solic­it­ing or deal­ing with cus­tomers. (As, in an employ­ment sit­u­a­tion, the court will rarely make an order enforc­ing a com­plete non-com­pe­ti­tion clause.) 

So, is it pos­si­ble to restrain an employ­ee for a much longer peri­od after they leave? How do you pro­tect the busi­ness’s legit­i­mate inter­ests and pre­vent for­mer employ­ees from exploit­ing their busi­ness rela­tion­ships or knowl­edge for a longer peri­od if that is what your busi­ness needs?

The answers are Yes – maybe and Some­times all it takes is to put some thought into the way the employ­ee is engaged by the busi­ness.

If the employ­er is a pri­vate com­pa­ny — offer the employ­ee shares. The share­hold­ing has to be mean­ing­ful and not token – but you can then tie the employ­ee up with a robust restraint (includ­ing non-com­pe­ti­tion pro­vi­sions) in a share­hold­ers’ agree­ment. And that restraint can sur­vive any sale of the com­pa­ny – pro­tect­ing the val­ue of the busi­ness for the major ven­dor share­hold­er and the buy­er (and, in the process, the trans­fer­ring employ­ees). For example:

5+ years

In a recent case, the court con­sid­ered the length of restraints that were enforce­able against the for­mer Man­ag­ing Director/​owner of an engi­neer­ing firm which had been sold. Over $500,000 was paid for good­will and the court decid­ed (in a deci­sion at an ini­tial stage any­way) that it is will­ing to enter­tain a restraint apply­ing for 10 years.

If it works, why not use it?

Maybe it is time for your busi­ness to think very care­ful­ly about the cur­rent arrange­ments for restrain­ing key employ­ees post-employ­ment. You prob­a­bly owe it to the share­hold­ers and the oth­er staff to make sure key staff are prop­er­ly restrained from dam­ag­ing the com­pa­ny when they leave. After all, with­out effec­tive post-employ­ment restraint claus­es – who real­ly owns the business?

This arti­cle was first pub­lished on LinkedIn as a blog. You can read the orig­i­nal here.