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Advanced Clauses in Employment Contracts

Most employers are aware of the legal requirements for a basic contract of employment,  but not all employers adequately protect their business, and many employment contracts do not contain the advanced clauses necessary to do so.

This article takes a closer look at some of the more advanced contractual terms to demonstrate why they are needed to protect a business.

Clauses to protect the business whilst the employee is in employment

Probationary period

This is a period at the start of the employment relationship, during which the employee is assessed on their performance and suitability for continued employment. A probationary period usually lasts three to six months and may involve formal or informal assessments. However, the length of the probationary period will usually be determined by the role and how long it will take the employer to assess performance. During the probationary period an employee's contract of employment can be terminated on shorter notice (subject to the minimum one week statutory notice period after a month of continuous service) and the employee may not be entitled to receive all contractual benefits until successful completion.

The disadvantage of a probationary period is the uncertainty for the employee, who may be concerned about giving up a secure job. It is important to notify the employee from the outset of the approach the employer intends to take with regard to expectations and targets that the employee is expected to achieve, together with the dates upon which any progress meeting will take place. It is also important to explain to the employee that they will be provided with feedback on their performance so that they have chance to address any issues prior to the conclusion of the probationary period.

It is also important to allow the flexibility of an extension, so that the employer is able to extend where the employee is not meeting the "required standards".  Many employers overlook the conclusion of the probationary period, and as a result the employee may argue that they have successfully completed it, when in actual fact they haven't. To safeguard the employer in that situation is it useful to state that the employee will be notified in writing of successful completion.

In the case of Przybylska v Modus Telecom Ltd UKEAT/0566/06, the Employment Appeal Tribunal held that an employer's express contractual right to extend an employee's probationary period was subject to an implied term to the effect that the probationary period would be extended for a reasonable time to allow the employer to provide some indication to the employee as to whether the probationary period had been successfully completed. When the employer failed to exercise the express right to extend Przybylska's probation, as provided by her contract, the probation finished on the date originally envisaged by the contract. The result was that, when the employer terminated her employment after the conclusion of the probationary period, the employee was entitled to three months' notice under her contract (rather than the one week's notice that the employer could have exercised during the probationary period).

Outside interests

The purpose of this clause is to control the employee's outside interests during employment. Implied into every contract of employment is the duty of good faith and fidelity, which includes a duty not to compete with the employer.

However, the extent of the duty is less onerous during the employee's spare time, and it only applies where competitive activity may cause serious harm to the employer. Also, a mere intention to set up in competition does not necessarily amount to a breach of the implied duty of good faith and fidelity and employees may take preparatory steps provided they are not in active competition. In the case of Hutchings v Coinseed [1998] IPLR 190, the Court of Appeal held that if there was no express restriction on outside interests, none would be implied. Therefore, it may be appropriate to include a clause that prohibits outside activities (unless the employer has given consent), or to limit the restriction to outside interests in competition with the employer.

Directors have a fiduciary duty to a company, which means they have to act in the best interests of the company and thus avoid conflicts of interest. However, it is advisable to include a clause as it draws the obligation to the attention of the director and, in the event of a breach.  Such a clause makes it easier to demonstrate the breach to the Courts if there has been an express prohibition within the contract.

It is worth remembering that if the employee is permitted to carry out any other work he/she should be required to give the employer details of the hours worked, as all time spent working is aggregated for the purposes of the Working Time Regulations 1998.

A blanket ban on outside interests may be unpopular with employees, particularly part-time employees. Therefore, it is advisable to state that outside interests may be permitted but only with the employer's written consent, which will not be unreasonably withheld.

Warranty not to breach covenants and right to work

This clause contains a warranty from the employee that he/she has the right to enter into the employment contract as well as a warranty stating that the employee has the right to work in the UK.

The aim of this clause is to focus the employee's mind on any restrictions that prevent them from entering into the employment relationship. The onus is therefore on the employee to ensure they are not prevented from working by non-competition clauses. An employer who employs someone despite knowing that they will be in breach of their obligations to a former employer (for example, if they are subject to ongoing restrictive covenants) may be liable in damages for the tort of inducing breach of contract. A warranty of this kind helps to show that the employer did not have the relevant knowledge before it employed the employee.

With regard to the right to work in the UK, this clause does not negate the fact that the employer has to carry-out the necessary checks before the commencement of employment. However, this sort of clause may help demonstrate that measures are in place to prevent illegal working which is important in view of the fact that an employer will be liable to a civil penalty if it negligently employs someone who is not entitled to work in the UK and will commit a criminal offence if it knowingly employs such a person.

Confidential information covenants

These clauses expand the common law duty of confidentiality that is implied into every contract of employment.

The implied term requires the employee to act honestly towards the employer, to disclose to the employer all information relevant to its business, not to make secret profits from the employer's business, to respect the confidentiality of the employer's commercial and business information and not to compete with the employer's business.

The extent of the implied duty of confidentiality will depend upon the type of information involved. Information that an employee is expressly told is confidential, and obviously is confidential as a result of its character, is protectable without express covenant during employment. However, despite the existence of the implied duty, it is advisable to expressly protect confidential information during the employment term as there is a grey area between information which is clearly confidential and that which is mere skill and knowledge. Careful drafting is crucial and the clause should clearly state what is deemed to be confidential, as such a breach of an express covenant is far easier to enforce than trying to rely on a breach of the implied term.

In the case of CoCo v AN Clark (Engineers) Ltd [1968] FSR 415, it was held that, when the Courts are required to consider whether particular circumstances imposed an obligation of confidence, an express statement in the employment contract stating that certain information is confidential will point towards such an obligation.

Therefore, when drafting such a covenant it is important to set out that confidentiality applies to all information that is classed by the employer as a "trade secret", why the business has taken steps to expressly protect its information (i.e. it is important and can damage the business if the information is used other than for the purposes of the business), it excludes information in the public domain, that damages may not be an adequate remedy and that the employer will be entitled to seek injunctive relief in the event of a breach and that the employee has had the opportunity to take legal advice on the meaning of the covenant.  And, don't forget to define properly what is or isn't confidential information.

Clauses to protect the business when the employee leaves

Restrictive covenants

Are terms that restrict employees' activities post termination. Post termination restrictions are particularly important where employees may have knowledge of technology, strategic information about the employer's business or customer contacts that they may try to use for the benefit of their new employer or business.

As previously discussed, employees are bound by certain implied terms during the duration of their employment, but these are of limited use and do not generally extend to the period after termination of the contract. As such, to protect legitimate interests of the business after termination, the contract of employment must contain post termination restrictive covenants. In addition, the presence of post termination restrictions may actually deter an employee from working for a competitor and/or warn off potential new employers.

The methods of restricting employees fall into two categories:

  • Restrictions applying while the employment relationship continues (as discussed above, but also during garden leave).
  • Restrictions applying after the relationship ends.

Garden leave comes into play when an employee decides to leave employment.  The employer might want to stop the employee from performing their regular duties immediately. However, at the same time, the employer might want to retain the employee for the notice period, typically requiring them to stay at home, to keep them away from a competitor for as long as possible. The aim of garden leave is to keep the employee out of the market place long enough for any information they have to go out of date, or to enable that employee's successor to establish themselves, particularly with customers, so as to protect goodwill.

Having an express garden leave clause may help deter a competitor from poaching employees in the first place and increase the employer's bargaining position with any disaffected employees. Such a clause may be used in conjunction with post-termination restrictive covenants for maximum effect.

Restrictive covenants are only enforceable where the employer can show that:

  • It has a legitimate proprietary interest that it is appropriate to protect.
  • The protection sought is no more than is reasonable having regard to the interests of the parties and the public interest.

Careful drafting is vital, as restrictions that are wide in nature, ambiguous or do not protect legitimate business interests will be deemed to be unenforceable, and the Courts will not substitute/amend onerous terms. For example, where a Court deems a restriction of 12 months post termination to be too long to protect legitimate business interests, the Court will not substitute the timeframe to a shorter more realistic one.  The benefit of the restriction will be lost if it is deemed unenforceable.

In the case of Mason v Provident Clothing and Supply Co Ltd [1913] AC 724 (HL), Mason entered into a severance agreement upon termination. The severance agreement contained a restriction that prevented Mason from working in the tissue industry for one year. However, he accepted an offer of employment within the tissue industry shortly after entering into the severance agreement and Provident sought to enforce the covenant. The judge at first instance found that the restriction was wider than necessary, but granted an order upholding a more restricted form of covenant, which required re-writing the original agreed covenant. However, the High Court held that the judge at first instance had erred in re-writing the covenant imposing limited terms other than those originally intended and agreed.

The employer should therefore consider the role of the employee and the threat to the business if that employee were to leave when drafting restrictive covenants, as there is no one size fits all.

It is also worth noting that a Court will treat separate restrictions as severable. If the clause contains what, in the Court's view, are two separate restrictions, where there are two clear separate restrictions, and only one is unenforceable, it will uphold the enforceable one and strike out the other. This is another example as to why it is so import to ensure that restrictive covenants are drafted carefully and specialist advice is sought.

If the employee is required to enter into restrictive covenants during the employment relationship (rather than at the outset), the employer must provide consideration for the restrictions. Restrictive covenants will be void (regardless of the drafting) in the absence of appropriate consideration.  Consideration is a benefit that passes from one party to another, and there must be reciprocal benefit for a contract to be enforceable. Therefore, if the employer has the benefit of the restrictions, there needs to be some valued benefit that passes to the employee, for example, a pay rise, or a one off payment conditional upon the employee agreeing to abide by the restrictions.  

In the case of FW Farnsworth Ltd and another v Lacy and others [2012] EWHC 2830 (Ch); [2013] IRLR 198 (HC), the employee was asked to sign an updated contract of employment. The new contract contained changes to the employee's advantage (such as private medical insurance cover), but others were to his disadvantage, these included post termination restrictions. The High Court found that if the employee had not taken the step of applying for the private medical insurance cover he would not have been bound by the new terms (which were unsigned).

For further detailed information on restrictive covenants please see the HR Network newsletter issue 3.

Atypical covenants

Atypical covenants are contractual terms that may be used (or may be viewed as being used) to limit unfair competition, and are a less direct means to protect business interests and to prevent competition. This means that some contractual arrangements, particularly in the form of remuneration or incentive practices, that appear neutral and innocent in fact have the effect of restraining employees' future work.  For example:

  • Deferred bonus schemes - formal arrangements under which payment of a proportion of an employee's earnings (usually bonuses or other variable compensation) is delayed to a date after the period to which their earnings relate. Payment is often made subject to the employee meeting certain agreed pre-conditions. Deferred remuneration schemes have become common practice in many workplaces, especially in the finance sector.
  • Deferred remuneration schemes operate as a "carrot" in the form of cash or stock, often deferred and subject to performance goals or alternatively as "stick" by having to repay if the employee leaves or undermines the employer's business interests.
  • Long-term incentive plan - is a discretionary remuneration plan used as a way of giving shares to employees at a future date for no consideration. Shares are normally only released if certain specified conditions, for example relating to performance, are met over a period of time. Given that the awards are free, the performance requirements are usually more onerous than under a discretionary bonus scheme. Such arrangements may include forfeiture clauses similar to those under a bonus scheme (for example, no payment to bad leavers).
  • Repayment of training course fees - some professions and industries subsidise or pay employees' training costs. Employers are able to include a clause in the employment contract dealing with repayment of training costs. Such clauses may require the employee to remain in the employer's employment for a certain period of time after the training and repay a portion of the fees if they leave their employment before a certain date. An obligation to repay training costs in these circumstances may have the effect of discouraging an employee from leaving, and so may be an indirect restraint of trade. 

The case of Strathclyde Regional Council v Neil [1984] IRLR 11 involved a social worker who had signed an employment contract which required her to stay with the Council for two years after completing specified training course. If she were to leave employment during that time she would have to repay some costs associated with her attendance on that course. She subsequently left within the two-year period and the Council sued her for repayment of the costs. The Court found that the claw-back/repayment clause was a reasonable restriction on the employee's freedom of action and could not be considered an unlawful restraint of trade. The Court also found that since the repayment was calculated on a sliding scale (so that the longer the employee stayed with the Council, the lower the repayment would be), it could not be considered a penalty and was a genuine pre-estimate of loss.

For atypical covenants to be enforceable, they should not be deemed to be an unfair restraint on trade. This sort of argument will arise where an employee wishes to leave their employer, perhaps to join a competitor, and does not wish to let go of the payments due to them, to have to repay money or let go of their shares. Since the effect of these arrangements could be to discourage an employee from leaving, there is an argument that these types covenants are unenforceable as being an unreasonable restraint of trade.

To guard against arguments of restraint of trade, the covenants should be reasonable and thus carefully drafted. The onus is on the employer to show that any restraint is reasonable, in the interests of the parties and designed to protect proprietary interest of the employer for which the restraint is reasonably necessary (customer lists and other such customer information are deemed to be proprietary interest). 

Pay in lieu of notice (PILON)

This clause is useful where employers want to terminate employment quickly where there are no grounds for dismissing the employee summarily. A PILON clause allows the employer to terminate the employment relationship immediately (but not necessarily fairly) without breaching the employment contract. Therefore the terms of the employment contract remain valid and the employee would continue to remain bound by any post termination terms (eg restrictive covenants).

However, payments under a PILON clause (even if the PILON is at the employer's discretion) are subject to tax and national insurance contributions (NICs). This is more costly for employers as employer NICs are also payable. As such, may employers choose to omit PILON clauses, especially if the contract of employment does not contain post termination restrictions.

The case of Geys v Société Générale, London Branch [2012] UKSC 63 it was held that where there is a repudiatory breach of contract by the employer, the contract will only end if and when the employee elects to "accept" the breach. So if the employer wishes to terminate employment summarily without cause and make a payment in lieu of notice and there is no provision in the contract allowing the employer to do so, the risk is that the employee may not accept this attempt to terminate their employment leaving the contract to continue. Although the omission of a PILON can give rise to tax advantages on termination, employers are, in light of the Geys case, encouraged to give careful consideration as to whether it is worth the risk of not including a PILON in the contract.

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