Enforcing Restrictive Covenants: the latest from the Supreme Court

Introduction

An employment contract tells an employee what they can and cannot do whilst employed. In some cases, the employer includes provisions about what an employee may not do after they have left employment. The contract can try to regulate questions such as stopping the employee from moving to a rival business, or starting their own in competition with their former employer’s; restricting the former employee’s approach to or solicitation of former clients, prospects and/or colleagues and use of the former employer’s confidential information. These are included in what are known as restrictive covenants or post termination restrictions. These provisions are found in many employment contracts. Naturally, these can have a serious effect on the employee’s ability to find or carry out new work. 

Tilman v Egon Zehnder Limited

This was no exception for Ms Tillman, whose appeal about a non-competition post termination restriction against Egon Zehnder Ltd (Egon) was recently decided by the UK Supreme Court.

It has long been established that restrictive covenants must be no wider than reasonably necessary to protect a legitimate business interest, and they must be in the public interest. They should not operate as a restraint of trade. If a restrictive covenant is deemed too wide to be enforceable, then the whole provision may be unenforceable. In the case of Ms. Tillman, the Supreme Court clarified the law on those situations where, rather than strike down a restrictive covenant as being void as an unreasonable restraint of trade, it might be possible for the Court to uphold it by deletion of certain words, making the covenant enforceable. This has long been an interesting area which the Courts have developed precedents as to the approach to be taken in such cases.

Supreme Court Decision

Ms Tillman, who worked in the financial services recruitment sector, was eager to move on to another position, which was with a competitor of her former employer. There had been a number of restrictive covenants in her contract with Egon, most of which she accepted. She maintained that whilst moving to her new job immediately would be in breach of the non-competition restrictive covenant, a part of the covenant was too wide to be enforceable, and consequently, the whole non-competition provision was void.

The provision provided that Ms Tillman would not “directly or indirectly engage or be concerned or interested in any business carried on in competition with any businesses of the company … which were carried out at the termination date or during such date” for a period of six months after her termination date with Egon. The words “…or interested in” made the restrictive covenant wider than necessary to protect the former employer’s interests. They prevented her from being employed by a competitor and also prevented her from possessing a minority shareholding in a rival company. She said this was a stark and unreasonable prohibition, given that she was free to hold such shares during her employment. It acted in restraint of trade and made the whole provision unenforceable.

Ms Tillman’s former employer mounted a number of arguments in support of upholding the restrictive covenants, notably:

  • The restriction on a shareholding in a rival company was not, in fact, subject to the law on restrictive covenants in employment terms and did not follow to be assessed as reasonable or otherwise; and
  • The restrictive covenants were subject to “severance” – i.e. the unreasonable part could be severed or removed from the provision allowing the remaining covenant as a whole to remain operational.

The English Court of Appeal declined to apply the severance approach. However, on appeal the Supreme Court overturned that decision. A bench of five Justices unanimously concurred that:

  • The restriction in the contract did fall within the law on restraint of trade in the employment sense as the holding of shares materially affected Ms Tillman’s post employment activities.
  • Being “interested in” was treated as including a prohibition on shareholding which was a restraint of trade and, on the face of it, made the non-competition clause void and unenforceable.
  • It was, however, within the Court’s power to extract and delete wording from a restrictive covenant, which is unreasonable due to such wording, but would be valid and enforceable otherwise. This would only be possible if the wording allowed severance i.e. deletion of words without substitution, if the remaining terms were supported by sufficient consideration (payment) and that removing the unenforceable provision doesn’t change the character of the contract entered into.

The Supreme Court held that the words “or interested” were removed from her contract, and that meant Ms Tillman was still unable to “directly or indirectly engage or be concerned in” any competing business. Whilst she could have held shares in her future employer, she would not have been able to start her new job immediately.

Comment

The Supreme Court’s judgment casts light on an area of the law which affects many businesses and individuals, although the enforceability of such restrictions will depend on their own terms. Although this is a decision of the Supreme Court arising out of an English case, it will be highly persuasive in the Scottish Courts as there are no material differences in the law of restrictive covenants in both jurisdictions. The decision raises important issues which impact on the employee and the employer alike:

  • Employers should consider carefully the drafting of restrictive covenants. They should be no wider than reasonably necessary to protect the employer’s legitimate business interests which will vary from employee to employee, each with different jobs, skills, and experience  in the employer’s organisation.
  • The judgment should not be used as a safety net by employers to fall into complacency when imposing such restrictions on their employees. A covenant should not be drafted widely in the hope that a Court would salvage some of it. It is more likely to be enforceable if it is specific and well focused.
  • Employees should thoroughly read and make sure the terms of a covenant are acceptable prior to signing. The employment contract (like all contracts) is a mutual agreement, and the parties are presumed to have exercised their free will when entering into one. Employees should not enter into contracts of employment containing restrictive covenants relying on their general unenforceability.
  • When relying on restrictive covenants, employers, and employees, should seek legal advice before reaching agreement.

This article was co-written by Martin Kotsev and summer student Damon Allan.

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