Are restrictive covenants and garden leave mutually exclusive?

TFS Derivatives Limited v Morgan

Frequently, an employer will wish to prevent former employees from leaving to work for competitors by incorporating in their contracts both a non-compete covenant and provisions for “garden leave”. This case concerned the circumstances in which relief is available to an employer seeking to enforce a non-compete covenant against a employee and the interaction between garden leave and non-compete clauses.

Facts

Simon Morgan was employed by TFS Derivatives Limited (TFS) as an equity derivatives broker. Due to the importance in the industry of building up relations within client organisations, Mr Morgan’s contract of employment included (1) a garden leave provision which could be exercised for the duration of his 3-month notice period or, at TFS’ option, up to 6 months and (2) a non-compete provision for a period of 6 months following termination of the contract which would be reduced by any period Mr Morgan spent on garden leave. After Mr Morgan had spent 3 months on garden leave, TFS learned that he had been recruited by a direct competitor and sought to enforce the non-compete covenant for the additional 3 months. Mr Morgan argued that the wording of the non-compete clause was overly wide, amounted to an unreasonable restraint of trade and should, therefore, be rendered void. In the alternative, he argued that enforcing the non-compete clause went beyond what was necessary to protect TFS’ legitimate business interests because the garden leave provision was altogether more reasonable.

Restrictive covenants

After reviewing the case law on restrictive covenants in employment contracts, the Court reiterated that it falls to the employer to justify as reasonable (in the interests of both the parties and the public) any contractual clause restricting an employee’s post-termination activities. The Courts use a three-stage process to assess such clauses: the Court will consider the real meaning of the relevant words in the employment contract; the employer must establish that it has a legitimate business interest and it must demonstrate the necessity and reasonableness of the scope of protection.

Mr Morgan’s non-compete clause stated that he would not “undertake, carry on or be employed, engaged or interested in any capacity in either any business which is competitive with or similar to a Relevant Business within the Territory, or any business an objective or anticipated result of which is to compete with the Relevant Business within the Territory”.

The Court confirmed several points which may be of interest to employers:

• 1. Where there is an element of ambiguity making it possible, but not necessary, to view a covenant as an unreasonable restraint of trade and therefore unlawful, the Court should adopt the view that the parties intended their actions to be lawful. The clause in question began with a preamble stating that the purpose was “to protect the goodwill, confidential information, trade secrets and business connections of the company…”. The Court held that such a statement is a very clear indication that the parties never intended the clause to apply to additional activities. The question is simply “what did these parties intend by the bargain which they made in the circumstances in which they made it?”. This guidance is good news to employers as it is contrary to the widely accepted rule that an ambiguous clause will be construed against the party who drafted it or who seeks to rely upon it (the contra-proferentem rule).
• 2. For employers, this point emphasises to the importance of clearly establishing and recording (preferably in the contract itself) what one is attempting to achieve and protect with a given clause. This gives the employee no room to argue later on that the clause is overly wide just because it could potentially have unintended consequences.
• 3. The words “any business” were the subject of some dispute, with Mr Morgan arguing that they could be taken to mean any legal entity. However, having regard to the nature of the business structure of the Claimant, the Court was willing to accept the view that the parties meant rather to refer to the particular business activity in which Mr Morgan was involved, namely equity derivatives trading. Whilst this was ultimately resolved favourably for the employer, this underlines the danger of using undefined terms in non-compete clauses.
• 4. In a similar vein, Mr Morgan argued that the words “in any capacity” could be taken to prevent him from taking any kind of employment with a competitor. However, the Court accepted that rather than referring to employment in any capacity, the phrase referred to being interested in any capacity in a competing business area, such as a situation where he might not necessarily have a contract of employment or a contract for service but still have a direct interest, for example, by being director of a company.
• 5. The use of the words “or similar to” made the company’s area of business particularly wide. Such phrasing was deemed in the circumstances to amount to an unreasonable restraint of trade. Employers might note that these words could and were in the circumstances “severed”, because it was possible to remove them without adding to or modifying the remainder of the clause and because such removal did not substantially change the nature of the contract. However, employers must be aware that it is not always possible to sever overly restrictive clauses because, as the Court emphasised, it cannot rewrite a contract or impute intentions to a party in order to correct an unenforceable contractual term.

Garden Leave

The most significant issue raised in the case was the fact that the contract provided for the ability of TSF to require 6 months’ notice and place Mr Morgan on garden leave for the full period. Mr Morgan argued that the garden leave provision was more secure, flexible and effective, and accordingly more reasonable, and that it should therefore be preferred to the non-compete clause. Although the Court was reluctant to provide detailed guidance on the role and usefulness of the two kinds of clauses, it was held that the inclusion of a garden leave clause in an employment contract would not necessarily render it unreasonable also to stipulate and rely on a non-compete clause:

• 1. garden leave may be considered even more onerous than a non-compete clause because it would keep the employee out of the workplace altogether leading to an “atrophy” of skills, contrary to public interest;
• 2. where an employee refuses to give notice and accept garden leave, the employer may still need a reasonable and enforceable non-compete clause;
• 3. enforcing a long garden leave period may amount to a breach of the implied term of trust and confidence in an employment contract; and
• 4. as to the question of fairness of continuing payment during the garden leave period and the restricted ability to derive income during the non-compete period, given the equality of bargaining power in a situation involving highly valued and most generously rewarded employees, non-compete clauses are less likely to be unreasonable between the parties.

Conclusion

It is noteworthy for employers that the Court observed that high-paid, high-powered employees such as Mr Morgan are more than compensated for the restrictions they may face upon conclusion of their contracts. Accordingly, this ruling is a victory for employers’ freedom to contract with their top employees, especially with those in demand who do have the power to negotiate, for whom non-compete provisions are most relevant and desirable.