Employment Law Partner Paul Maynard discusses restrictive covenants.
Most well drafted Post-Termination Restrictive Covenants contain what is known as a “Severance Clause”. In essence this is a statement that the parties intend each restriction to be a separate promise, separately enforceable. In other words, if a court finds that any particular restriction is too wide to be enforceable, the parties invite the court to delete the words that cause the promise to breach the doctrine of restraint of trade – a process colloquially known as “blue pencilling”.
Ultimately, however, it is a matter for the court to determine the extent to which restrictions can be regarded as distinct and severable. For many years the law relating to a court’s ability to sever words from a contract was contradictory and unclear. Whether or not a contract contained separate promises, was sometimes an accident of drafting, could be very difficult to ascertain and often led to arbitrary results.
Take for example, the illustration cited in one of the cases dating back to 1920. A covenant not to carry on business in Birmingham or within 100 miles was capable of severance by blue pencilling the words “or within 100 miles” so as to limit the restriction to Birmingham itself. On the other hand, a covenant not to carry on business within 100 miles of Birmingham cannot be severed as it would require the court to rewrite the covenant rather than to simply delete words. The distinction is wholly artificial but in the first example a large part of the restriction is saved, whereas in the second none of the covenant survives.
This question of severance was recently considered by the Supreme Court (in Tillman v Egon Zehnder) – the first time an employee competition case has come before the most senior court in the land in over a century. The outcome should be regarded as a victory for employers….. and for common sense.
Ms Tillman was employed by the UK subsidiary of a global executive search and recruitment group – Egon Zehnder (EZ) in 2004 having previously been employed by JP Morgan as its European Managing Director. As expected she was rapidly promoted from Consultant to Principal, to Partner, and then to joint Global Head of EZ’s Financial Services Practice Group in 2012. Despite her promotion she remained subject to the same restrictive covenants that were in her Contract of Employment when she started.
The dispute revolved around the interpretation of a six month non-competition covenant whereby Ms Tillman agreed that she would not “directly or indirectly engage or be concerned or interested in any business carried on in competition” with the EZ Group.
Her contract also stated that if any of the restrictions were held not to be valid as going beyond what was reasonable for the protection of the goodwill and interests of EZ, but would be valid if part of the wording was deleted then the covenants would apply in their modified form – in other words a severance clause.
When Ms Tillman’s employment came to an end she notified EZ that she intended to start work with a competitor three months into the six month period of restraint. She argued that she was not bound by the non-competition as it was an unreasonable restraint of trade and therefore void.
Her principal argument was that the words “indirectly… interested in any business” precluded Miss Tillman from holding any shares (regardless of the size of the shareholding) in any competing business and this rendered the clause too wide to be enforced. EZ argued that the phrase was ambiguous and in those circumstances the court should strive to interpret the clause in a way that would render it valid so as to give effect to the parties original intentions – it being presumed that neither party would have intended to enter into a prmise that was unenforceable.
Despite conflicting decisions from the High Court and the Court of Appeal, the Supreme Court was clear that the unambiguous meaning of the words “interested in” was that it covered a shareholding, whether large or small, and on that basis it was an unreasonable restraint of trade. The Supreme Court also considered the meaning of the words “concerned…in” and concluded that unlike “interested …in” which could denote a mere passive interest in a business, “concerned” should be interpreted differently to mean having an active involvement in a business and as such this did not overstep the boundary of what activity it was reasonable for EZ to restrain.
The key issue, and most important part of the Supreme Court’s decision, was whether the offending words “interested in” could be severed and removed from the rest of the clause so as to save its enforceability.
Having conducted a root and branch review of previous cases the Supreme Court has now confirmed that the following criteria will apply in future severance cases:-
- The offending words must be capable of being removed without needing to add to or modify the remaining words – the previous “blue pencil test”.
- The remaining terms must continue to be supported by adequate consideration.
- The removal of the words or provision would not generate any major change in the overall effect of all the post-employment restraints in the contract.
Applying these principles to Ms Tillman’s case, resulted in the words “or interested” being severed from the non-competition covenant without the need to add to or modify the wording of the remainder. This could be done in such a way so as not to generate any major change in the overall effect of the restraints. Accordingly those words were severed thereby saving the remainder of the covenant from being struck down for being in restraint of trade and upholding EZ’s right to the injunction that had initially been granted by the High Court.
This judgement will undoubtedly be welcome news for employers who may be faced with a technical and highly opportunistic challenge to the post-termination restraints. It also demonstrates how urgent cases such as this can be expedited – with just three months of the non-competition covenant remaining there was still sufficient time to have the application for an interim injunction heard by the High Court and considered in full by the Court of Appeal.
The Supreme Court nevertheless sounded a warning to employers whose restrictive covenants are saved only by interference from the courts through the application of the blue pencil test. The Court described as “legal litter” the unreasonable parts of post-employment restrictions which they are asked to sever and which it said, casts an unfair burden on others to clear up. In such circumstances the employer should not expect to be able to recover all, or indeed any of their costs. As the Supreme Court put it, EZ “should win… but there might be a sting in the tail”.
The overarching lesson for employers is that post-termination restrictive covenants should go no further than are strictly necessary to protect the employer’s legitimate commercial interests. To that extent they should err on the side of modesty, be clear in their meaning and kept under regular review. Ideally, restrictive covenants should always be drafted by a solicitor specialising in employee competition law.
Further information on the enforceability of restrictive covenants can be obtained from our recently updated briefing note