The Supreme Court has considered the use of restrictive covenants for the first time in almost 100 years. The judgment looked at the scope of the restrictive covenant doctrine in order to determine the correct test for severance of a post-termination restriction.
What are restrictive covenants?
Restrictive covenants are often included in contracts of employment or in corporate transaction documents. They are notoriously difficult to enforce because a court’s starting point is that they are an unenforceable restraint of trade. It is not possible to stop employees from fairly competing after leaving employment. However, it is possible to restrict unfair competition. Essentially, the law allows an employer to restrict a former employee for a limited period and in limited ways from unfairly benefitting from their insight, connections, and experience gained whilst working for that employer.
A covenant will be enforceable only if shown to be necessary, and no more than necessary, to protect the employer’s legitimate business interests. The onus is on the employer to demonstrate that there is a legitimate business interest to protect and that the protection afforded by the covenant is no more than is required to protect it. If the covenant goes beyond what a court considers necessary, then it will be, and often is, struck down.
Egon Zehnder, an executive search and recruitment company, employed Ms Tillman to work in its financial services practice as a consultant from January 2004. Ms Tillman was promoted and, by 2012, she was the joint Global Head of the Financial Services Practice. Her original contract of employment included five post-termination restrictions, which were not updated at any time during the course of her employment. The covenants applied for six months following the end of her employment. After Ms Tillman left Egon Zehnder in January 2017, she told the company that she was going to start working for a competitor. She made it clear that she would comply with all of her covenants, other than the non-compete restriction. She said that it was an unreasonable restraint of trade and therefore void. This clause was central to the Supreme Court case and provided that Ms Tillman would not:
"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 [she was] materially concerned during such period."
In April 2017, Egon Zehnder raised proceedings, applying for an interim injunction to prevent Ms Tillman taking up the new role. The injunction was granted by the High Court and we reported on the decision at the time. Ms Tillman then appealed to the Court of Appeal, who set the injunction aside. When considering whether the non-compete covenant was enforceable, the Court of Appeal focused on the words "interested in", finding that this unreasonably prevented her from holding even a minority shareholding in a competing business. As such, it was an unreasonable restraint of trade and the Court of Appeal refused to sever the words from the clause to save the rest of the covenant.
Ultimately, the case made its way to the Supreme Court in January 2019, and the judgement was published at the start of this month. When considering the proper construction of the words "interested in", the Supreme Court found that the words "engaged or concerned or interested" appeared as standard in precedents for non-compete covenants and that long-standing authority had shown that this covered a shareholding. The Court held that it extended to holding even a minor shareholding (of any size) in a competing business.
The Supreme Court also looked at the correct approach to severance, and set out the test that should be followed, often referred to as the blue pencil test. The first part of the test involves looking at whether the unenforceable part of a covenant can be deleted without otherwise amending the rest of the restriction to make it work. The second part is determining whether removing the offending words will create any major change in the overall legal effect of the restrictive covenant. In the case of Tillman, the Supreme Court overturned the Court of Appeals decision, holding that the offending words "interested in" could be severed from the covenant without needing to add to or modify the rest of the clause and without having any major impact on the overall effect of the remaining covenant.
Effect of the decision
The covenant in question expired in July 2017, long before the case got to the Supreme Court, so it will not restrict Ms Tillman from competing with the company in the future. The decision will however be a relief to employers, who may have been worried about the enforceability of their covenants. It sets a precedent that otherwise unenforceable covenants may be capable of amendment by blue pencilling certain words to render the covenants enforceable. However, this does not mean that a court can go as far as rewriting a covenant. Employers should still seek to ensure that covenants are tailored, precisely drafted, and kept under review, to avoid the time and expense of later having to prove that the covenants are reasonable and enforceable.