Contractors, having your hands contractually tied as IR35 reform looms? Then check those ties

Having their hands tied in an already tight situation is far from what limited company contractors would choose as we approach a new IR35  on April 6th, but that may be the reality for some PSCs using agencies where there are restrictive covenants in play, or at least so a growing number of queries to us indicate, writes Leila Ghazzali, trainee solicitor and Carla Roberts, director, both of WTT Legal.

In short, is there a contractual penalty risk of accepting a permanent role with the end-client, or engaging with the client as a small consultancy delivering your services under a Statement of Work (SOW), if you are currently working as an agency contractor via a PSC?

When you want to move out of reform’s way, but can’t -- seemingly

In anticipation of the off-payroll reforms coming into force in exactly six weeks’ time, we’re starting to see a resurgence of blanket banning by end-clients who want to sidestep the hassle of implementing the reforms.

These issues from an end-client and agency perspective are covered elsewhere, but from a contractor’s perspective, consideration needs to be given to the implications of accepting a role with the client on a PAYE basis, particularly as their member of staff. But the same consideration about the contractual ramifications needs applying if you’re a contractor who wants to stay on with your current client post-April 6th and stay independent, albeit by developing your services-offering into your own small consultancy.

Let’s explore. Prior to the incoming off-payroll reforms, many contractors engaged through their own PSC would have provided services to the end-client through an agency.

Restrictions in your PSC-agency contract look like…

Some contractors, now looking at alternatives, are realising that there are restrictions in the contract between the PSC and the agency which may prevent the contractor from engaging with the end-client, either directly or indirectly.

This may include restricting the contractor from:

  • becoming a permanent employee of the end-client;
  • engaging with the end-client on an outside IR35 basis with a third-party or another agency
  • providing the end-client with services on a consultancy basis under an SOW.

In the current climate, where contractors might be are experiencing difficulty finding roles but are simultaneously being forced to amend their working practices, it is important that contractors can move to their next opportunity with impunity.

The ‘reasonably necessary’ test

However, many contractors engaged with a client, through an agency, who would like to continue that relationship have concerns that the restrictions in their contract may prevent this.

Not all restrictions are enforceable, and it is important to understand that restrictions only become enforceable if the agency can prove that it is ‘reasonably necessary’ to protect any legitimate business interest.

What are Restrictive Covenants?

A restrictive covenant is typically a clause in a contract which prohibits a business or an individual from carrying out certain actions during an assignment or after the contract has terminated. The most common types of restrictions are

  • Non-Solicitation – this prohibits the contractor from poaching the client/agency’s clients/candidates/staff  
  • Non-Dealing – this prohibits the contractor from engaging with the client’s/third parties/other agencies, other than through the agency
  • Non-Compete – this prohibits the contractor from working for a competitor of the agency in a competing capacity

When considering a post-termination restriction, the general rule is that the enforceability of a restriction could potentially be a restraint of trade. The restraint of trade principles state that a restriction which interferes with a person’s right to earn a living in the way they choose will only be enforceable if it goes no further than reasonably necessary for the protection of the legitimate commercial interest of the party imposing it.

Additionally, the contract between a contractor and the agency will likely include a restrictive covenant which prohibits the contractor (and its representative) from working directly or indirectly for the client or its subsidiaries. This means that arguably a contractor could not provide services to the end-client through another agency, or as a sub-contractor to a small consultancy providing SOW services to the end-client. However, again, the restriction must be reasonable to be enforceable.

What’s ‘reasonable,’ and what‘s likely unenforceable

The reasonableness of a restriction is influenced by different factors and should be considered on a case-by-case basis

It is likely that the restrictive covenants will impose a restriction prohibiting the contractor from engaging with the end-client, effective from the date the contract has commenced and for a further period after termination. A reasonable period for post-termination restrictions is usually six months. Twelve months may also be imposed and would be borderline enforceable depending on the circumstances.

Generally, if the contractor has been engaged in a senior role with a specialist skill-set or is party to confidential information, then a longer duration is likely to be enforceable. However, any restriction longer more than 12 months would generally be difficult for the agency to enforce, as case law shows that it is rare for a court to allow a restrictive covenant that lasts for over 12 months. Furthermore, a restriction that is longer than the actual assignment duration is unlikely to be enforceable.

A geographical restriction may also be included in the clause. However it cannot be too onerous. For example, prohibiting the contractor to work in the whole of the UK would be unenforceable.

Next contractors, run the ‘legitimate business interest’ test

Secondly, an important point to emphasise is that in order to enforce the restriction there must be a legitimate business interest to protect. Therefore, in considering circumstances where the end-client is no longer willing to accept contractors operating through their own PSCs for assignments, it is arguable that there is no longer a business interest for the agency to protect and therefore, any enforceability of the restriction would constitute an unlawful restraint of trade and fall away.

Furthermore, it is arguable that although the agency may still possibly be able to supply PAYE temporary workers to the end-client, they are unable to provide the services of a contractor working through their own PSC on a business-to-business basis, and therefore an entirely different contract would need to be agreed with an individual, rather than a business.

Enforceability of the restrictions always depends on individual circumstances and facts, so we strongly encourage contractors to take a considered approach when assessing whether a restrictive covenant applies. As issues arising as a direct result of off-payroll reforms are unique, it should also be noted that this is an untested area of law and it is likely that we will see some cases of this nature in the courts in due course.

Conduct Regulations

Another issue to consider when assessing the enforceability of any restrictive covenant is the Conduct of Employment Businesses and Employment Agencies Regulations 1996.

In order for an agency (assuming they are acting as the “Employment Business” as defined under the regulations) to enforce a restrictive covenant, they are required to ensure that the contractor agrees to opt-out of the regulations and specific procedural rules must be followed by the agency (as stipulated under the regulations). These are as follows:

  1. The opt-out form must be signed by both the contractor as an individual, the director on behalf of the PSC and the agency
  2. The opt-out form must be signed before the assignment starts
  3. The end-client must be informed before the assignment starts  

While most contractors would have signed an opt-out notification, the question is whether the notification was entered into validly -- and it could be incumbent upon the agency to demonstrate that they complied with all three requirements.

Final thoughts (includes you not being in the dock)

The changes resulting to models of engagement arising from the IR35 off-payroll reforms on April 6th are of course not the only reason why a restriction may be enforced against a contractor by the agency (i.e. there may have been a breakdown in a relationship between the client and the agency which limits the contractor’s engagement with the client).

As we approach the final handful of weeks before the reform bites, it is important to consider your restrictive covenants before accepting your next role. In the rush to get things sorted ,it may be tempting to ignore a restriction or hope that your contractual partners don’t notice it! However the consequences could result in costly legal actions, injunctive proceedings or the agency seeking damages. We do therefore strongly recommend taking legal advice when reviewing your restrictions and planning your next move, to both maximise your working opportunities and to avoid become one of those future court cases in this area which we are bound to see.

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Written by WTT Legal

WTT Legal is a fully equipped, SRA regulated law firm, which delivers comprehensive legal advice on a wide number of practice areas, with specialist knowledge of tax, wealth and employment matters. Working within various sectors of the professional services market, we provide our clients with unparalleled levels of expertise in a simple and transparent manner akin to the wider company ethos.

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