Supreme Court judgment on post employment restrictive covenants – impact for employers?

Restrictive covenants are common features in employment contracts that limit an employee’s future commercial activities to enable an employer to protect its business after that employee has left.

The courts traditionally view restrictions after the termination of employment as being “in restraint of trade” and, for public policy reasons, will not enforce them unless certain conditions are met. In order to be enforceable, an employer must be able to show that the covenant in question goes no further than is reasonably necessary to protect the legitimate interests of its business. The courts will look to strike a balance between protecting the employer and allowing the employee the freedom to work where they choose and take advantage of their own professional skills and knowledge.

In some circumstances the courts can remove (or “sever”) unlawful elements of a restrictive covenant leaving the remainder in place to be enforced.

The judgment in Tillman v Egon Zehnder Ltd is of particular significance as it afforded the Supreme Court the first time in a century to consider restraint of trade in an employment relationship and, most importantly, the circumstances in which the courts can exercise the power to sever unlawful provisions from a restrictive covenant.

Background

Ms Tillman was employed by headhunter firm Egon Zehnder Ltd (“EZ”) from 2003 until her resignation to join a competitor in 2017. At the time she left EZ she was co-Global Head of the Financial Services Practice Group, a key profit-making division of its business.

Broadly, Ms Tillman’s contract of employment included a six-month post termination non-compete restriction. This prohibited her from engaging in or “being concerned or interested in” any business that competed with those businesses of EZ or its group companies with which Ms Tillman had been materially concerned at the date of termination of her employment or in the 12 month period leading up to it. The covenant did not include a minimum threshold for a permitted minor shareholding, as is often the case in modern employment contracts.

Upon resignation, Ms Tillman made it clear that she intended to comply with all of the restrictions in her contract with the exception of the non-compete restriction. Ms Tillman’s key argument, which has been considered now all the way up to the Supreme Court, was that the non-compete restriction was too wide to be enforceable in that it prevented her from holding even a very small shareholding in a competing business. To be clear, Ms Tillman did not propose to hold any shareholding in a competing business during the active period of the non-compete. However, she used this argument to disregard the non-compete and commence her new employment.

Injunctive relief

EZ was granted an interim injunction in the High Court to enforce the non-compete and prevent Ms Tillman from starting work at the new competitor firm for the six-month period of the restriction. In granting the injunction, the judge said that the non-compete did not prevent Ms Tillman from becoming a shareholder in a competing business; it followed that it was not too wide and was therefore enforceable.

Ms Tillman appealed and the Court of Appeal set aside the injunction which, by this time, had only a few days left to run. The practical effect therefore became an argument about which party’s interpretation was correct for deciding which party should bear a proportion of the other’s legal costs. The Court of Appeal disagreed with the High Court and decided that the term “interested in” prevented even a minor shareholding in a competitive business; as such, the restriction was too wide and in unlawful restraint of trade. It went on to consider the issue of severance and whether it could save the covenant by removing the words “interested in”. The Court of Appeal declined to sever, applying a line of previous decisions that essentially provided that severance was available only if the parts proposed to be severed were independent of other remaining covenants, and this was not the case here.

Overruled by the Supreme Court

In overturning the Court of Appeal’s decision, the Supreme Court has held that the restraint of trade doctrine applies and so the covenant is limited by the need for reasonableness. The words “interested in” did also prevent Ms Tillman from holding any shares in a competing business, and this rendered the covenant too wide to be reasonable. Most significantly, however, it found that the phrase “interested in” could in fact be severed from the covenant leaving the remainder untouched, thereby narrowing its scope again and making it enforceable. In so ruling the court has confirmed three issues that must be considered when deciding whether it is appropriate for the courts to exercise their power to sever an unlawful element of a covenant. Broadly these can be set out as three questions:

• is the unenforceable provision capable of being removed without the need to add to or modify the wording of what remains (the so-called “blue pencil” test)?

• can the remaining terms continue to be supported by adequate consideration (this will usually be the case)?

• can the unenforceable provision be removed so that it does not generate any major change in the overall effect of all the post-employment restraints in the contract? It is for the employer to establish this.

In this case the Supreme Court decided that the answer to all three of the above questions was yes and the covenant, as severed, was enforceable.

Practical points

• It is useful to have confirmation that “interested in” – a common phrase used in restrictive covenants – has its every day meaning and will cover holding shares even as a passive investor. In this case the employer could not come up with a plausible alternative as to why it included the term “interested in” in the restrictive covenant if it was not intended to mean holding shares. This highlights the need for parties to be clear about what they intend by the language used and to tailor the restrictive covenant to individual circumstances.

• Often covenants that restrict an employee from holding shares in a competitor include a carve out permitting shareholding for investment purposes below a certain threshold, for example 3% or 5% – had this been included in the covenant in this case, it would have been more likely that the restriction would have been enforceable without the need for severance (or expensive litigation!). However, there was no guidance as to what threshold would be enforceable and employers will need to justify on a case-by-case basis why a particular threshold is reasonable.

• Although the restrictions were found to be enforceable, given that the post termination period had long since expired the real issue at stake was whether one party should bear the other’s legal costs and to what extent. The court made clear that there might “be a sting in the tail” for an employer that extracts unreasonable restrictions from employees and then calls upon the courts to “clean them up” when elements prove to be unenforceable. This is an important strategic consideration for employers who may rely on very broad restrictions in the hope or expectation that at least some of it may be enforceable after severance.

• Any employers considering revisiting their existing employees’ restrictive covenants in light of this case or otherwise should remember that, in England and Wales, consideration needs to it be provided for the covenant to be enforceable. This could take the form of a one off payment, a pay rise or introduction of a new benefit provided that payment is genuinely contingent on agreeing to the new restrictive covenants and would not have been paid in any event.