Tillman v Egon Zehnder Ltd - Restrictive covenants: 'severance'

In a landmark ruling, the Supreme Court has confirmed that unreasonably wide wording in a post-termination covenant can be removed, and the covenant still enforced, if this does not generate any significant change to the overall effect of the restraint.

Despite the common myth, organisations are able to use and enforce non-compete restrictions in order to protect their business interests when employees leave the business. However, a restrictive covenant which serves to restrict trade needs to be the result of a legitimate proprietary interest and reasonable in the circumstances concerned.

In situations where the covenant has attempted too wide a restriction, tribunals may work to ‘sever’ the unlawful words or provisions in order for the restriction to then be enforceable.  Previously, the Court of Appeal has outlined in the case of Beckett Investment Management Group Ltd v Hall that ‘severance’ can only take place in the following circumstances:

  • the provision that is to be removed must be done so without having to modify or add to the terms that remain, otherwise known as the ‘blue pencil test’
  • the terms that remain must continue to be supported by adequate consideration
  • the removal must not serve to change the contract to the extent that it essentially becomes entirely different to what was intended by both parties.

Usually, it is common practice for organisations not to try and restrict employees from holding shareholdings in competitor companies as an investment.

FACTS

This case concerned an employee, Ms Tillman, who had established a long and successful career as an investment banker. She was recruited to work for the respondent, Egon Zehnder, as a consultant. Ms Tillman was seen as a ‘considerable prize’ by the respondent, who offered her a higher salary than consultants at her level would usually earn and promoted her several times.

After 13 years working for the respondent, Ms Tillman resigned. In the following week, the respondent terminated her employment with immediate effect and provided her payment in lieu of notice. The reason for Ms Tillman’s earlier resignation, which she only now disclosed, was that she wished to go and work for a competitor of the respondent’s who was based in New York. In response to this, the respondent issued proceedings against her and sought an injunction, arguing that this would be a breach of her six-month non-compete clause as outlined within her contract of employment.

Her contract instructed that she could not, directly or indirectly, ‘engage, or be concerned or interested in’ any business that was in competition with the respondent at the termination date for a period of six months from her termination, unless she received prior written consent from the company. An additional clause stated that if any of the restrictions or obligations outlined were held to not be reasonable for the protection of the ‘goodwill and interest of the Company’, but would be valid if part of the wording was deleted, then the restriction would apply following the modifications.

Ms Tillman argued that this non-compete clause was not enforceable as it was wider than reasonably required for the protection of the respondent’s legitimate business interests. A particular point of contention was her not being able to be ‘interested in’ a competing business, as it prevented her from having a minor shareholding in a competitor for investment purposes.

HIGH COURT

The High Court initially granted an injunction to restrain the breach. They held that the contract did not serve to prevent Ms Tillman from having a minor shareholding in a competitor organisation, meaning that it was not wider than was reasonably necessary.

COURT OF APPEAL

The Court of Appeal overturned this ruling. To them, interpreting the words ‘engage or be concerned or interested in’ as being restricted to ‘active’ participation was wrong. They found that the non-compete restriction was too wide as it was not possible for a shareholder within a company to be not ‘interested in’ that company in accordance with conventional usage. Severing the words ‘interested in’ was also not possible in this situation as the clause in question represented a single covenant. It had to be read in its entirety in order for it not to be changed beyond what was intended.

SUPREME COURT

Whilst the Supreme Court agreed that the words ‘interested in’ did prevent the employee from having a minor shareholding in a competitor company, these words were able to be severed.

In forming their decision, the Court first considered whether it was reasonable for a restrictive covenant to place a prohibition on having shareholdings in a competitor organisation. They outlined that it was necessary to consider the position of an employee as someone at her level of seniority would frequently be subjected to conditions that she needed to hold shares in the organisation that employed her. Therefore, this prohibition would have restricted her ability to work following her termination, which was too wide a restriction.

Although the respondent tried to argue that prohibiting the employee in maintaining minor shareholdings was not the case, and had it been so they would have specifically outlined this, the Supreme Court held that the phrase ‘engaged or be concerned or interested in’ represented a standard precedent in drafting non-competition clauses and included a prohibition on maintaining shareholdings.

Turning to the issue as to whether the words ‘interested in’ could be severed, the Court held that the approach as outlined in Beckett should apply. It was possible to remove these words without needing to modify or add to the clause.

Note for employers

In this landmark ruling, the Supreme Court have essentially reaffirmed the Beckett approach and, as a result, organisations may seek to draft restrictive covenants more widely than they have done. This does create a degree of uncertainty for employees; covenants that they previously thought were unenforceable could actually end up being enforceable if particular clauses can be removed from them to make it so.

That said, it should also be noted that the Supreme Court did refer to unreasonable parts of post-employment restrictions as ‘legal litter’ that can ‘cast an unfair burden on others to clear them up’. The implication to take from this is that it will be organisations who have to bear these costs, meaning that whilst covenants can be drafted more widely, they should proceed with caution.

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