Five years ago I wrote an article for this blog which was entitled “Don’t rely on a court to fix a ‘defective’ restrictive covenant“. In doing so I was merely using a recent case to demonstrate the approach taken by courts to restrictive covenants in employment contracts, viz. that they have to be precise and correct in all respects, failing which they are likely to be struck out in their entirety. That’s why you often see a sub-clause at the end of series of restrictive covenants which states something along the lines that if any covenant or part thereof should be found to be unenforceable, that shall not invalidate the remainder: an attempt to pre-empt the likely outcome if the clauses are subjected to court scrutiny.

Restrictive covenants in employment contracts, and particularly those which seek to restrict a former employee from joining a competitor, can be difficult to enforce in practice. That’s because they are a form of restraint of trade which, on the face of it, is contrary to public policy. However, courts have acknowledged over the years that employers have legitimate business interests which they ought to be able to protect, but only to the extent that it is reasonable to do so. Consequently, such restrictions should be reasonable in area and duration, with the restrictions providing no more protection than is reasonably necessary. The received wisdom has been that if they go too far, they are likely to be struck out altogether. Since court proceedings in this field can be cumbersome, time-consuming and very expensive, often with no guarantee of a successful outcome and with an opponent who might not be in a position to pay costs if ordered to do so, employers have tended to be understandably wary about litigating and have instead relied on the deterrent factor of including such clauses in contracts.

Nonetheless, over the years there has been a good deal of litigation concerning restrictive covenants, very often considering what restrictions are reasonable in terms of their scope and application. However, it has been over 100 years since restrictive covenants have been considered by our most senior court. That is until the judgment of the Supreme Court in the case of Tillman v Egon Zehnder Limited, which was handed down on 3 July.

Ms Tillman is one of the City’s best known and most successful financial services headhunters. In 2003 she joined Egon Zehnder Limited as a consultant. She was promoted to principal in 2006, became a partner in 2009 and joint global practice head in 2012.

In early 2017 she left with the intention to join the New York office of Russell Reynolds Associates, a rival. Her employment contract with Egon Zehnder included a fairly typical non-compete clause:

You shall not without the prior written consent of the company directly or indirectly, either alone or jointly with or on behalf of any third party and whether as principal, manager employee, contractor, consultant, agent or otherwise howsoever…directly or indirectly engage or be concerned or interested in any business carried on in competition with any of the businesses of the Company or any Group Company which were carried on at the Termination Date or during the period of 12 months prior to that date and with which you were materially concerned during such period.

Paragraphs 7 and 9 of the judgment

As is so often the case, the contract also included a clause dealing with the possibility that parts of the restrictive covenants might be held as going beyond what was reasonably necessary:

If any of the restrictions or obligations contained in this clause 13 is held not to be valid as going beyond what is reasonable for the protection of the goodwill and interest of the Company … but would be valid if part of the wording were deleted, then such restriction or obligation shall apply with such modifications as may be necessary to make it enforceable.

Paragraph 9 of the judgment

In this case, at least in the lower courts, the contentious part of the restriction was whether or not the restriction of being “interested in any business carried on in competition with [the employer]” extended to prohibiting her from holding shares in any such company.

In April 2017 Egon Zehnder applied to the High Court for an interim injunction preventing Ms Tillman from commencing her proposed employment which was granted by Mr Justice Mann. Ms Tillman appealed successfully to the Court of Appeal. In both courts the key question was whether the words “interested in” unreasonably prevented her from having even a very minor shareholding in the competing business and, if so, whether the offending part of the restrictive covenant could be severed. Mr Justice Mann took the view that “interested in” did not preclude a minor shareholding and therefore did not need to reach a view on severance. The Court of Appeal disagreed, finding that the words “interested in” did prohibit a minor shareholding and refused to sever the offending words. Accordingly the clause amounted to an unreasonable restraint of trade and Ms Tillman was not bound by it.

The Supreme Court unanimously allowed Egon Zehnder’s appeal. The Company contended that a restriction on holding shares was not a restraint of trade, so the doctrine of reasonableness did not apply. Lord Wilson, delivering the lead judgment, disagreed. He concluded that, for such a senior employee, it was not surprising that the employer did not want her to hold shares in a competitor and this was an aspect of the employer’s steps to prevent her from competing, thus falling within the doctrine of restraint of trade.

Second, in any event, the clause did not directly prevent the employee from owning shares in a competitor, so the restriction (if indeed there was a restriction) was not too broad. However, Lord Wilson took the view that “interested in” included having a shareholding. There was no realistic alternative interpretation.

Third, it was contended that this part of the covenant could be severed, to enable enforcement of the remainder. This is the most interesting part of the judgment, not least because it marks a significant departure from the received wisdom concerning such matters.

For many decades, employment and contract lawyers have relied on the Court of Appeal decision in Attwood v Lamont [1920] 3 KB 571, in which it was held that severance of an offending part in order to enable enforcement of the remainder should not generally be permitted. Lord Wilson concluded that this keystone of dealing with restrictive covenants should be overruled. In its place, he outlined a three stage test to be applied.

  1. “The unenforceable provision is capable of being removed without the necessity of adding to or modifying the wording of what remains”. This is sometimes referred to as the blue pencil test which, in essence, means that offending parts may be removed as long as what remains still represents the original meaning. For example, deleting the word “not” from a clause would not pass the blue pencil test.
  2. “The remaining terms continue to be supported by adequate consideration”. In this context “consideration” means transactional value (the exchange of one thing of value for another), an essential element of an enforceable contract. This will not normally be an issue.
  3. “The removal of the unenforceable provision does not so change the character of the contract that it becomes ‘not the sort of contract that the parties entered into at all'”. In practice this is just another way of saying that the contract should retain its overall meaning and intent. In other words, there should not be any major change in the overall effect of the post-termination restraints in the contract. What this means is that minor changes may be made but there will be no wholesale rewriting.

So, what did the decision mean in practice for Ms Tillman. Well, not a lot given that the restriction period had long since expired by the time that the judgment was handed down. You might have thought that the real penalty would be in legal costs but here there was a word of warning from Lord Wilson, stating that, to use the words of another judgment, unreasonable post-termination covenants “cast an unfair burden on others to clean up” and although the Company should win, “there might be a sting in the tail”.

Of course, the best approach is to ensure that restrictions are reasonable in scope and duration, so that they are not liable to be struck out. Although the judgment provides some comfort for employers, it should be borne in mind that the cost of putting things right, if court proceedings are required, could be considerable.