Clarity is the best policy when drafting post termination restrictions
Employers can breathe a collective sigh of relief this week as the ongoing saga over the enforceability of post termination restrictions in the case of Tillman v Egon Zehnder has finally reached a sensible conclusion in the Supreme Court.
Post termination restrictions are only enforceable against employees if they go no further than is absolutely necessary to protect the ex-employer’s business. It’s long been the view that if a restriction is drafted too widely to be enforceable, but would be enforceable if words were removed, those words could be severed and the restriction could then be enforced. This is known as the “blue pencil” test. This was a handy “get out of jail” card for employers with wide restrictions; however, the judgement by the Court of Appeal suggested this was no longer the case.
Ms Tillman was a senior employee at Egon Zehnder for many years before resigning in January 2017 and soon after took up employment with a competitor. Under her employment contract with Egon Zehnder she was subject to various restrictive covenants, one of which included a six-month post termination non-compete restriction – i.e. preventing her from working for a competitor. The wording included a restriction on being “interested” in a competitor. Ms Tillman maintained this particular restriction was unreasonable and therefore void because the word “interested” meant she could not hold any shares in a competitor should she choose to.
Egon Zehnder successfully obtained an injunction preventing Ms Tillman from working for the competitor. The Court deemed the covenant to be reasonable and that “interested” did not mean shareholding.
Ms Tillman successfully overturned this decision at the Court of Appeal. It agreed, perhaps unsurprisingly, that “interested” did include shareholding and was therefore too wide as it would capture any shareholding however minor. However, it also reached the more surprising conclusion that the covenant could not be severed to remove the words “or interested” in order to render the remainder of the covenant valid. First, the Court of Appeal’s view was that the wording “directly or indirectly engage or be concerned” still could be construed as to include shareholding. Secondly, a more general principle view was taken that a single covenant cannot be severed – which was news to the legal drafting world.
What did the Supreme Court say?
As per the Appeal court, the natural construction of “interested” in a business covers shareholding, whether large or small. It is therefore too wide and thus an unreasonable restraint of trade.
Contrary to the Appeal court, the Supreme Court took the view that the covenant could be severed to remove the offending words, without changing the meaning or effect of the covenant. The Court emphasised the already established “blue pencil” principle of severance, that it must cut things up and does not extend to adding things in.
The Court also clarified that, contrary to the Court of Appeal’s conclusion, “directly or indirectly engage or be concerned” did not refer to shareholding, as previous case law had already established. Plus, as the Court pointed out, why include “interested” if “concerned” meant shareholding? Deleting the former cannot change the meaning of the latter.
Why is this important?
For a number of reasons. We no longer need to panic that covenants that could be construed as preventing a minority shareholding in a competitor (of which there are likely to be many, given the common use of the word “interested”) will be deemed automatically void if challenged – there is scope for severance, if they can be “blue pencilled”.
There is no longer a need to be overly cautious with separating covenants out for fear that one offending word could cause the whole covenant to collapse.
There may now be a feeling of less urgency to redraft covenants to remove any wording that might capture a minority shareholding as a result, but best practice would be to re-draft because:
- Such covenants are now at higher risk of challenge given Tillman, and the Courts will not be impressed by an employer who is seeking to rely on the principle of severance to enforce an otherwise unreasonable covenant.
- Despite the power to sever wording, litigation is uncertain – there is no guarantee the courts will do it. It may therefore be safest to keep covenants as separate and distinct as possible.
- Clarity is always the best policy. The Supreme Court has recognised that it is perfectly reasonable to prevent an employee from becoming a majority and/or controlling shareholder in a competitor for a period post-termination. Therefore, if an employer wishes still to capture shareholding, be clear in the drafting that minority shareholding (with no controlling powers) is permitted.
Final food for a litigator’s thought…
Egon Zehnder appear to have won the order for costs, but reluctantly. Be wary, therefore, that winning a covenant dispute through the severance back door may not get you your costs – if the court views their role as having to tidy up the employer’s mess.
Evie Meleagros is a senior associate in the Dispute Resolution Department and a member of the HRLaw team.