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Unreasonable non-compete clause could be rescued by severance

03 July 2019

The Supreme Court (“SC”) has given a landmark judgment about the limits of post-termination restrictions (“PTRs”) in employment contracts. It ruled that although a six-month non-compete clause went too far by restricting an employee from holding a minority shareholding in a competing business, the employer could still enforce the key part of the clause.

Background

PTRs, also known as “restrictive covenants”, are commonly included in employment contracts and can include restrictions on a former employee’s activities in various ways. These include the individual’s ability to poach clients, entice away key staff, interfere with supply chains or simply compete with the former employer’s business for a defined period of time after their employment ends (typically three to 12 months).

Non-compete clauses have become more popular in the modern workplace, as employers try to protect their intellectual property and confidential information as well as their customer and workforce stability.

The legal doctrine of “restraint of trade” provides that restrictive covenants are valid only if they go no further than reasonably necessary in the circumstances. The courts can, however, perform a type of contractual surgery known as “severance” where any unreasonable part of a covenant is removed, leaving the rest of the covenant intact and enforceable.

The PTR at issue in this case was a six-month non-compete clause in an employment contract between the global executive search firm, Egon Zehnder, and its former co-head of global financial services, Ms Tillman. The clause provided that Ms Tillman could not directly or indirectly engage or “be concerned or interested in” any competing business for six months after her employment ended.

When Ms Tillman resigned to join a competitor, Egon Zehnder sought an injunction to stop her from doing so. In response, Ms Tillman maintained that the non-compete clause was so unreasonably wide that it was unenforceable. Her key argument before the SC was that the clause even caught a passive minority shareholding, and so went further than was necessary.

Supreme Court’s decision

What have we learnt from the SC’s judgment?

  • The doctrine of restraint of trade did apply to the non-compete clause, despite Egon Zehnder’s argument to the contrary. Any restraint on shareholding is part and parcel of a restraint on an employee’s ability to work.
  • Being “interested” in a competing business includes being a shareholder of that business, whether large or small. The non-compete clause was essentially a bar on Ms Tillman having anything whatsoever to do with a competitor - even holding a small shareholding as a passive investor. So, the non-compete clause as originally drafted was unreasonably restrictive.
  • Nonetheless, the part of the non-compete which prevented shareholdings could be severed. There is no need for a phrase to be in a separate covenant, or to be trivial or technical, in order for severance to apply. The SC overruled a Court of Appeal authority to that effect dating back to the 1920s (Attwood v Lamont).
  • The law is now clear that a non-compete can be severed if: (1) the unreasonable part can be deleted without needing to add extra words; (2) the remaining terms continue to be supported by consideration; and – crucially - (3) the removal of the unenforceable provision would not generate any major change in the overall effect of the PTRs in the contract.
  • Here, the words “or interested” could be removed from the non-compete clause, leaving the remaining part enforceable (the restriction on Ms Tillman being engaged or concerned in a competing business).
  • The phrase “concerned in” a business did not include holding a passive shareholding in that business, so did not require deletion.
  • Although Egon Zehnder was entitled to its injunction, there might yet be a sting in the tail. Unreasonable parts of a PTR could neatly be described as a form of “legal litter,” and employers could expect to bear at least part of the cost of clearing it up.

Implications for employers

This decision is mostly good news for employers. Ultimately, the SC has come down on the side of an employer’s right to enforce reasonable restrictions, even where they may be accompanied by unreasonable ones. The SC emphasised, however, that courts would continue to adopt a cautious approach to PTRs. With that in mind, these are what we see as the most significant implications:

Employees may be less likely to challenge enforceability of PTRs. Following the Court of Appeal’s decision in this case, we saw a major upturn in employees arguing that PTRs were void on the basis of their drafting or the way in which they were set out. The SC’s decision on severance means that employees are now less likely to risk the costs of those sorts of challenges (which were highlighted by a recent case).

Employers should still not overreach when drafting PTRs. The judgment will make many employers less nervous about the wording of PTRs that they have already agreed, but which are too challenging to change. The SC’s approach to severance offers some reassurance that, if parts of those PTRs are found to go too far, the other parts could still be enforceable. Yet it remains the case that it is always better to have narrower restrictions you can be confident of enforcing, rather than wider restrictions which go too far. Remember to bear in mind the theoretical width of your PTRs. Arguments about their reasonableness will often turn on what they prevent in theory rather than what the employee actually wants to do (as in Ms Tillman’s case).

Consider your position on shareholdings. In this case, it was unreasonable to prevent Ms Tillman from acquiring a minority shareholding, but there may be other cases in which it is legitimate to restrict ex-employees from holding shares in competing businesses. That will depend on the circumstances, the type of business and the size of the shareholding. Many PTRs contain a carve-out for minority shareholdings, which is usually sensible.

Reaffirm your PTRs on promotions. Ms Tillman had agreed the non-compete clause when she was first hired as a (relatively junior) consultant. By the time she left to join a competitor 13 years later, she was the co-global head of the financial services practice group. She (rightly) pointed out that the reasonableness of the six-month non-compete needed to be judged at the time she joined. This issue was dealt with in an earlier stage of the case, when the High Court found that a six-month non-compete clause was reasonable in principle even at the time she joined, given that she was recruited as a high-flyer and in anticipation of a higher-than-normal level of engagement with business strategy and clients. This point did not come up again in later stages of the case, but it would have been better - and might have avoided any dispute on the point altogether - if her employment contract had been reissued and reaffirmed each time she was promoted.

Tillman v Egon Zehnder Ltdjudgment available here

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