Chop but don’t change: The Supreme Court considers severance in restrictive covenant cases

Evie Meleagros and David Butler from Fox Williams’s Dispute Resolution practice discuss the Supreme Court’s decision in Tillman v Egon Zehnder

Employers concerned to restrain their departing employees from working for competitors will sleep more easily at the end of this week following the decision of the UK Supreme Court in Tillman v Egon Zehnder, an important decision considering the principle of severance in restrictive covenants. 

Background

Ms Tillman was a senior employee and then a partner in the recruitment business Egon Zehnder for many years. At the end of January 2017 her employment with Egon Zehnder came to an end. Soon after she told Egon Zehnder that she intended to begin to work for a competitor from 1 May.

Ms Tillman’s employment contract with Egon Zehnder included post-termination restrictive covenants, including one which provided that for a six-month period following the termination of her employment she would not “directly or indirectly engage or be concerned or interested in any business carried on in competition with any of the businesses of [Egon Zehnder] or any Group Company which were carried on at the Termination Date…”, in other words, a non-competition clause.

Egon Zehnder thought very highly of Ms Tillman and thought that the competitor would do so too. It applied for an injunction to enforce the non-competition clause and Ms Tillman agreed with the company that she would not work for the competitor pending the outcome of the case.

The decisions in the courts below

Ms Tillman’s defence was that the non-competition clause was void because it went further than was necessary to protect Egon Zehnder’s interest and was therefore an unreasonable restraint of trade. She put forward a number of arguments in support of that position, the principal one being that the use of the words “or interested” meant that the covenant prevented her from having even a very small shareholding in a competing business, which made it too broad. Egon Zehnder argued that properly understood in context the non-competition clause did not prevent Ms Tillman from holding a minority shareholding in a competitor but that, even if it did, the words “or interested” could (and therefore should) be severed (deleted) from the provision to make it enforceable.

The High Court accepted the employer’s arguments and found against Ms Tillman. Ms Tillman appealed.

The Court of Appeal agreed, perhaps unsurprisingly, that the word “interested” did include a shareholding and was therefore too wide to be enforceable as it would capture any shareholding, however minor. It also reached the more surprising conclusion that the words “or interested” could not be severed in order to render the remainder of the covenant valid. There were two reasons for that. First, the Court of Appeal’s view was that the wording “directly or indirectly engage or be concerned” could still be construed as to include shareholding. Secondly, the Court of Appeal stated that the words could not be severed because they appeared in a single covenant and it was not permissible to delete words in a single covenant.

This second proposition was unwelcome news, as it was generally thought that the law had been settled the other way in a Court of Appeal decision given in 2007. Egon Zehnder asked for permission to appeal to the Supreme Court.

Supreme Court decision

Following a comprehensive review of some 500 years of English case law and decisions in Canada and Singapore, the Supreme Court in a judgment given by Lord Wilson allowed Egon Zehnder’s appeal.

It held:

In agreement with the Court of Appeal, the natural construction of the word “interested” in the non-competition clause covered a shareholding, whether large or small. The non-competition clause was therefore too wide and void as an unreasonable restraint of trade. 

Disagreeing with the Court of Appeal, the words “directly or indirectly engage or be concerned” did not refer to shareholding, as previous case law had already established. As the Court pointed out, if the word “concerned” meant or included shareholding, the word “interested” would be meaningless.

Disagreeing with the Court of Appeal, it was not the law that words in a single covenant could not be severed. The test in all cases was the three-fold one set out by the Court of Appeal in Beckett Investment Management Group Ltd v Hall (2007). In approving it the Supreme Court refined the third element of the test, so that it is now whether:

1. The unenforceable provision is capable of being removed without the necessity of adding to or modifying the wording of what remains (the “blue pencil” test).
2. The remaining terms continue to be supported by adequate consideration.
3. The removal of the provision would not generate any major change in the overall effect of all the post-employment restraints in the contract.

A valuable reset

Following the Court of Appeal’s decision in this litigation employers and their advisors had become concerned that many existing employment contracts would need to be re-written with each covenant being set out individually and compendiously so that, if it came to litigation, there would be no need to rely on the principle of severance to save a clause. The Supreme Court’s decision means that employers do not need to undertake what might be a difficult process of getting their staff on to new contracts.

Employers also 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 held unenforceable if challenged. There is scope for severance, if the offending words can be “blue pencilled” and what is left does not represent a major change in the overall effect of the post-employment restrictions. In this regard, the Supreme Court pointed out that when evaluating whether there has been a ‘major change’ “The focus is on the legal effect of the restraints, which will remain constant, not on their perhaps changing significance for the parties and in particular for the employee.”

A cautionary tale … with a sting in it?

While the Supreme Court’s decision is a welcome restatement and removes the immediate need to rewrite contracts, it was a lengthy and expensive way to get it. Greater clarity at the outset would have avoided the need for litigation. 

Clauses such as the one examined in this litigation are often lifted from standard forms or practitioners’ works or precedent documents. Just because they have been used for years without being questioned doesn’t guarantee that they won’t come under the microscope. There is no substitute for precision and clarity. If you are an employer and you want to limit the ability of an employee to be involved with a competitor post-termination, think carefully about what it will take to protect your company’s legitimate interests; the level of protection to which an employer is entitled may not be universal. And if you consider that it is necessary to prevent an employee having a shareholding or ownership interest in a competing business, make sure that this goes no further than is legitimate, for example by carving out purely minority ownership interests.

Finally, although the employer won, it could not do so without the court lending a bit of a helping hand and severing the offending words. The Supreme Court indicated that notwithstanding the employer’s victory “there might be a sting in the tail”. What that sting might be is not clear. One speculation may be that where in future an employer seeks an injunction but in order to get it the court is asked to sever offending words, this will have implications in terms of either the relief that is granted or how the costs of the injunction proceedings or any broader litigation are awarded or assessed.