Winning the war for talent: Deterring defections to competitors

When it comes to litigation to slow or stop the recruitment of a team by a competitor, disputes are often resolved in confidential negotiations or with recruiting firms getting cold feet once plans are unearthed. But as the war for talent rages, the tide may be turning. The stakes are high, but the risk of doing (or being seen to do) little could be a green light for a raid by competitors.

In the last year, US law firm focus on the City’s profitable work has grabbed the headlines. But so too has City firms’ apparent fightback, with reported confiscation of profit distributions, bolstered restrictive covenants and departure lounge clauses on the leadership agenda.

The starting point is that contractual terms purporting to restrict an individual’s freedom to work or carry out their trade will be void unless they go no further than necessary to protect a firm’s legitimate business interest, such as client connections, workforce stability and confidential information (the misuse of which can be difficult to police and protect by confidentiality obligations alone). Typical terms under the spotlight are provisions restricting post-termination activity. However, the doctrine can apply to provisions operating during the currency of a contract where the provisions are oppressive or exorbitant.

While there are no clear limits to the scope of the doctrine, the focus is on the practical effect of the restraint in hampering freedom of trade. A provision which has become part of the ‘accepted machinery’ of a type of transaction, generally found to be acceptable and necessary, will usually fall out of scope.

Steel v Spencer Road LLP [2023] relied on Tullett Prebon v BGC Brokers [2010] as precedent for the proposition that repayment of sign-on/retention payments (clawbacks) did not amount to a restraint of trade where employees did not perform their role for the period required to avoid the effect of the provision. The decision in Steel required the repayment of a substantial bonus (over three times salary) on Mr Steel’s resignation within one month of its payment where the payment was contractually repayable if Mr Steel (a head-hunter) left or was under notice (given or received) within three months of its payment. While the court recognised it was a deterrent from resigning, it did not prevent Mr Steel from working elsewhere; it was encouragement to stay in the role as opposed to a fetter on post-termination activity.

Accountancy and financial services firms have long deployed creative tools to deter movement to competitors. My experience and a 2023 Association of Partnership Practitioners survey indicate that the legal profession may be following suit.

The following trends fall to be scrutinised under the usual restraint of trade principles:

• Bolstering the firm’s suite of restrictive covenants – use of non-competes (restraining a partner from moving to a competitor for a defined period, typically 6-12 months) appears to be on the rise; and
• Introduction of team-move covenants, seeking to prevent members from joining a competing business which engages other ex-members to provide similar services. There is limited authority in relation to enforceability of such covenants. In principle, it is thought they will be enforceable to protect the stability of the workforce, customer connections and the firm’s goodwill. Given the limitations it places on members, careful drafting is key.

The following appear to be growing in popularity, with the scope for challenge less certain. They are likely to demand a two-stage analysis: i) is the clause, in fact, a restraint of trade; and ii) if so, is it reasonable by reference to the interests of the parties and the public:

• Reductions of profit share during garden leave. A practice long adopted by the big accountancy firms, there is nothing inherently unlawful about such activity provided it is a feature of the members’ agreement. Any challenge is likely to be regarding the exercise of any discretion and compliance with conditions;
• Deferred income and capital profits and/or payments conditional on leaver status, which may be linked to compliance with post-termination restrictions. They may fall for consideration under the restraint of trade doctrine if linked to joining a competitor or moving as part of a team;
• Use of departure lounge clauses. These are clauses that limit the number of partner departures in a stipulated timeframe. They can be used to disincentivise teams or tiers of (key fee-generating) partners moving at a similar time. Questions around the number of partners which trigger the clause, interaction with garden leave, operation after the trigger is met and whether the trigger should apply to people in a team or across the firm more generally, will all fall to be considered; together with the legitimate business interests, if the clause is challenged as a restraint of trade, and reasonableness becomes a focus.

There have been no reported cases in relation to departure lounge clauses and it is unclear whether they will be regarded as restraints or akin to long notice periods, which are typically enforceable. An increased prevalence may also gain their recognition as ‘accepted machinery’. The devil is likely to be in the details. Careful drafting is likely to be key.

Predictions

• In light of Steel, firms may look to introduce deferral of profit share distributions, clawbacks and departure lounge clauses, as an additional deterrent to protect the firm and its members from aggressive recruitment strategies.
• Post-termination restrictions will continue to offer key protection, particularly at an interim stage to ‘hold the ring’ pending a trial of the issue of enforceability, but are likely to be easier to challenge in the long run, and require careful drafting to ensure scope and breadth are reasonable.

Firms ignore the cultural implications of these tools at their peril. Deferral and withholding of profit shares are likely to make it expensive for partners to leave or be bought out by a recruiting firm, but may not be received well by a hard-working member body that may have operated without such provisions for some time. Good governance practices should be followed to implement any change.

Caroline Field is a committee member of the London Solicitors Litigation Association and partner at Fox & Partners