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Supreme Court issues landmark restrictive covenant ruling

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The Supreme Court handed down its much anticipated ruling yesterday in the case of Tillman v. Egon Zehnder Limited. The primary issue before the court was whether words could be severed from a restrictive covenant clause in order to render it enforceable and not invalid as an unreasonable restraint of trade.

Background

Ms Tillman was employed by the management consultancy firm, Egon Zehnder Ltd, in numerous roles from 2004, before progressing to Global Head of Financial Services in 2012. When she later resigned in 2017 and sought to join a competitor firm, Egon Zehnder argued that this was a breach of the non-compete provision in her employment contract.

The clause in question stated that she would not “directly or indirectly engage or be concerned or interested in” any business carried on in competition with Egon Zehnder for six months following her termination. Ms Tillman’s stated reason for not observing the clause hinged on the words “interested in”. She argued this wording prevented her from holding even a minority shareholding in a competitor and therefore the covenant was wider than necessary to protect her former employer’s interests, and thus invalid as an unreasonable restraint of trade. The majority of non-competition clauses in employment agreements include an explicit exception which permits the employee to hold up to a certain percentage of shares (usually 5%) in any publicly-listed company.

The decision

An injunction application from Egon Zehnder was initially granted by the High Court on an interim basis but subsequently set aside by the Court of Appeal (CoA). The CoA agreed with Ms Tillman that the words “interested in” covered a shareholding and were therefore unduly wide. The CoA held that severance could not be applied and therefore the non-compete restriction was deemed unenforceable.

Egon Zehnder appealed to the Supreme Court, in the first employment competition case to have reached the Supreme Court and its predecessor in more than a century.

Regarding the words “interested in”, the Supreme Court agreed that under their natural construction they would cover a shareholding (large or small) and that as such the non-compete restriction would be an unreasonable restraint of trade, subject to the application of severance. Significantly, however, the Supreme Court went on to find that the offending wording could be removed or severed without the need to add to or modify the rest of the clause and that the removal would not generate any major change to the overall effect of the restrictions. Accordingly, the non-compete clause was held by the Supreme Court to be otherwise enforceable.

The Supreme Court overruled existing case law on severance and set out a three-fold test for severance as follows:

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

The impact of the decision

The Supreme Court’s decision represents a minor victory for employers as it shows that courts will sometimes be prepared to come to the rescue of overly-broad restrictive covenants.

Despite this ruling, the test remains that restrictive covenants should go no further than necessary to protect an employer’s legitimate interests. Non-competes are the harshest form of restrictive covenant and are the most difficult to enforce. It is therefore important that they are properly drafted. Non-competes should carve out small shareholdings. Thought should also be given to how all types of restrictive covenants are structured to maximise the application of the blue-pencil test, as set out above, should the issue of severance become relevant