Restrictive covenants: a win-win for partner mobility

Despite the never-ending political and economic uncertainty clouding the UK, the legal services market mostly continues to thrive. The sector was valued at an estimated £32.7 billion in 2017, an increase of 3.8% on the market value the year before (Consultancy.uk, 2018). 

This continued success has meant that firms are prepared to increase the pay package to attract partners. This has contributed to an increase in partner mobility, with partners on the hunt for exciting (and well paid) opportunities.

With such an increase in partner mobility, firms are now seeking greater protection from the potential loss of clients should one of their partners leave the firm. However, firms must consider carefully the most effective way to protect their interests when a partner decides to leave.

One form of protection is through restrictive covenants. Restrictive covenants mean the firm will be in a stronger negotiating position when a partner moves. One of the trends we have seen in this area is firms introducing a non-compete covenant to prevent a partner working for a competitor. This is in addition to the the non-acting and non-soliciting covenants, which seek to prevent the partner from acting for the old firm’s clients at his new firm.

It is well known that the restrictive covenants applying to partners are usually more extensive than those applying to employees. Part of the rationale for this position is that the leaving partner is disposing of his or her share of goodwill in the partnership, which is being acquired by the continuing partners and for which the continuing partners are entitled to protection for their acquired asset.

Partners are also considered to have an equality of bargaining power compared with the employer-employee relationship. Many partners may find that principle challenging, but covenants look set to remain as part of the infrastructure of most law firms.

Although the goal for many law firms is to establish clients of the firm and not clients of a partner, the reality is that many client relationships are maintained through a personal relationship. This means it is highly likely a client will want to follow a partner if they leave.

In this context, restrictive covenants serve a dual purpose. They offer the firm a window in which to establish the client with different personnel at the firm. When it is clear a client will be leaving no matter the firm’s efforts to keep them, the covenants give the firm a negotiating position with the partner. This will also be the position if the firm is not able to properly service the client when the partner has left. Therefore, the value of the covenants to the firm can be in negotiating a release.

We have seen firms willing to negotiate compensation for the release of a leaving partner from restrictive covenants. In contrast to a negotiation position, a buyout clause would set out the price which the leaving partner (or in practice, usually the new firm he is joining) would need to pay in order to for the leaving partner be free from the restrictive covenants. Firms often refrain from including this kind of liquidated damages provision for a release of a covenant because including a binding buyout clause may indicate that damages would be an adequate remedy for a breach. This may jeopardise the opportunity to obtain an injunction for a covenant breach. In this context, firms should consider how likely it is that they will ever want to obtain injunctive relief.

There are other factors firms should consider when introducing a buyout clause. Obtaining significant damages for a breach of a restrictive covenant has proved difficult. The availability of 'negotiating damages' seems less likely and the law on penalties has been clarified. For a payment to qualify as an unenforceable penalty, the payment must not be disproportionate, though it can be an amount which is not a genuine pre-estimate of loss.

In these circumstances, firms may opt for the greater financial certainty of a buyout provision. That would at least give some compensation for the time spent developing a client. A buyout clause does not need to apply equally to all clients – it could be a condition applied on the hiring of a new partner or to a specific class of clients.

By choosing a buyout provision, partners will be able to move with clients more easily. Hiring laterals may be more expensive but the blow of losing partners will be softened.

Doug Preece is a partner at Fox Williams LLP