A restrictive covenant will only be enforceable if it protects a legitimate business interest; and is no wider than reasonably necessary to protect that interest (so will usually be limited by reference to the restricted activities, duration and geographical extent). In Tillman v Egon Zehnder Limited the Supreme Court was asked to consider what happens if part of the covenant is unreasonably wide – can the remaining reasonable parts of the clause still be relied on?
In January 2017 Ms Tillman resigned with notice from Egon Zehnder to go and work for a competitor. Her contract required her for six months from the termination date not to “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.”
Egon Zehnder issued proceedings, alleging that by working for a competitor Ms Tillman would be in breach of her non-compete clause. She argued that the covenant was void as it was wider than reasonably required for the protection of legitimate business interests. In particular, she claimed that a restriction on being ‘interested in’ a competing business was too wide as it could prevent her from even having a minor and passive shareholding in a competitor. She also argued that the overly restrictive part of the covenant could not be ‘severed’ or struck out to allow the rest to be enforced.
Supreme Court decision
The Court of Appeal had found that the non-compete restriction was impermissibly wide because of the inclusion of the words ‘interested in’, resulting in the entire restrictive covenant clause being void. However, the Supreme Court allowed the appeal.
- The words ‘interested in’ include a shareholding, whatever its size. Therefore, as drafted the non-compete provisions were too wide and unenforceable as an unreasonable restraint of trade.
- However, the Court went on to find that the words ‘interested in’ could be removed from the clause so that the remainder of the non-compete provisions could remain in place and be relied on.
It will not always be possible to remove unreasonable words from a covenants clause. In relation to severance, the Supreme Court laid down the following criteria:
- Can the unenforceable wording be removed without having to add to or modify the remaining words? (’the blue pencil test’)
- Does removing the unenforceable wording create any major change in the overall effect of all the post-employment restraints in the contract?
Applying these criteria to Ms Tillman’s case, the words ‘interested in’ could be removed without having to change the remaining wording; and without generating a major change to the overall effect of the covenants. As a result, Egon Zehnder could rely on the remaining part of the restrictive covenant clause.
The Supreme Court has confirmed the severance test, which potentially allows employers to rely on otherwise unenforceable restrictive covenant clauses. However, the courts will not always be prepared to find the criteria for severance satisfied and in fact the Supreme Court noted that, “The courts must continue to adopt a cautious approach to the severance of post-employment restraints“. It also highlighted the fact that employers will not necessarily recover their costs where they win a case only because the court has removed the unenforceable part of a covenant.
Severance should, therefore, be viewed as a last resort. Best practice is still to draft covenant clauses carefully and to consider their enforceability relative to the individual employee. In particular:
- Think about precisely what types of competitive activity should be restricted post-termination. Consider what the business wishes to protect itself against in each case looking at the employee’s role, seniority, type of work, degree of access to confidential information; level of client contact etc.
- Individual restrictive covenants should be separate obligations so that, in the event that one is found to be unreasonable and so void, it can be severed while preserving the enforceability of the remaining restrictions.
- If the non-compete clause contains a restriction on being ‘interested’ in a competitor after termination, expressly state that minority shareholdings (often defined as shareholdings of between 3 and 5%) in a competitor are nevertheless permitted. This will help to ensure that the covenant is enforceable and avoid arguments about severance.
- Consider specifically agreeing in the contract that unenforceable provisions can be deleted from the clause.
- A covenant’s reasonableness will be determined as at the date the contract was entered into, not at the time of termination. Accordingly, restrictive covenants should be reviewed periodically to ensure they remain relevant and enforceable.
If you have any queries on drafting or reviewing covenants, please get in touch with your usual Brodies’ contact. Workbox users can also access more information at the pages on Employee Restrictions.
On July 9, 2019