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SELWYN BLOCH QC WRITES ON THE UPCOMING SUPREME COURT DECISION IN TILLMAN V EGON ZEHNDER: RESTRICTIVE COVENANTS AND THE FUTURE

Introduction 

  • While the ETA of the Supreme Court decision in Tillman v Egon Zehnder Ltd[1] (argued in the Supreme Court on 21-22 January 2019) draws nearer, thoughtful employment lawyers may worry over the enforceability of restrictive covenants they have drafted.
  • How many practitioners will have foreseen that routine non-compete language “be interested or concerned” in a competing business (often following the words “engaged or”) could create such problems for employers, such as Egon Zehnder?
  • The problem for Egon Zehnder was exacerbated by the presence - in a commonplace provision prohibiting the employee having an interest during employment in a competing business - of an equally commonplace exclusion from that prohibition of a 5% interest in a publicly quoted company.
  •  Unfortunately for Egon Zehnder, this made the prohibition applying after employment (which did not exclude a % holding in a publicly quoted company) wider than that applying during employment. 
  • Mrs.Tillman was lucky indeed to be able to rely on what would appear to have been drafting error of no particular practical consequence (given that she had no intention of becoming a shareholder in a publicly quoted competitor - or any competitor). Even odder is that she would apparently have had no complaint had the 5% exclusion also been included in the post employment non-compete i.e. no complaint if (for the covenant period of 6 months after employment) she had been barred from having an interest of between 6% and 100% in a (publicly quoted?) competitor. This was all but conceded in the Supreme Court (in principle if not in detail). The size of the shareholding is (of course) significant because a substantial shareholding would normally come with active engagement in the competitor whereas a small shareholding would normally entail only a passive (or pure financial) interest in the competitor. It would be unreasonable (so the argument runs) to bar out such a (nominal) interest when it would carry little or no risk of breach of confidence (the usual protectable interest underlying non-competes) compared with where the involvement in the competitor would be an active one.
               1. [2017] IRLR 906 (CA)
  • Seen in this way, Mrs Tillman’s real complaint was not being permitted to have a small shareholding in a (publicly quoted?) competitor company, something which she never intended to acquire. While (of course) it is the intention of the parties at the time of the contract which is important when testing the enforceability of restrictive covenants, one cannot help wondering whether such a drafting slip was not de minimis - attracting the principle in Home Counties v Skilton [1] (ie that the court will not strike down restrictive covenants because they are too wide in “extravagant” or unlikely circumstances). However, the arguments proceeded along a different track.
                  2. [1970] 1 All ER 1227

Severance 

  • The most interesting aspect of this appeal is the proper approach of the courts to the doctrine of severance.
  • The issue of severance raises vital public policy considerations. Should the courts allow employers to sever parts of restrictive covenants so as to allow enforcement of the rump? Is this not unfair to employees who may be faced with the cost and anxiety of litigation, defending widely drafted covenants, only to find that after severance, a narrower covenant is enforced? Should the employer, who drafts too widely not be made to sleep on its own bed? On the other hand, should an employee who has a agreed for good consideration to a covenant, be allowed to wriggle free from it because of some imperfection in the drafting, which had no practical effect?
  •  Alternatively, is there a middle course which would enable the court to sever offending parts of a restrictive covenant fairly generously but to apply a public policy corrective in cases where the employer has behaved oppressively by deliberately drafting too widely and then before the court seeks to retrieve the position by relying on severance? The addition of such a corrective was suggested by Jonathan Sumption QC (as he then was) in Marshall v NM Financial Management Ltd [1].
  • The Supreme Court in Tillman is faced with a seemingly stark choice between:
  1. the mechanistic approach of the Court of Appeal in Attwood v Lamont[1], allowing severance only of independent promises -the basis of the Court of Appeal’s decision in Tillman not permitting severance; (this often begs semantic questions of whether the part which is sought to be severed is or is not an “independent” promise);      
  2. he substantive approach of the Court of Appeal in Beckett Investment Management Group Ltd v Hall [1] (applying Sadler v Imperial Life Assurance Co of Canada Ltd[2]). Under the Sadler test, the court will (assuming the other elements of severance are satisfied) allow severance, unless to do so would change the character of the contract so that it becomes “not the sort of contract that the parties entered into at all”. 

           3. [1997] IRLR 449                 4.[1920] 3 KB 571 (CA)

Are the two tests different?

  • The Court of Appeal in Tillman suggested that there was no difference between the two tests. That approach is unpersuasive (to say the least). The one is a formalistic test and the other a substantive test. That is not to say that there is no connection between the two tests. The fact that the covenants are contained in separate promises may be an indication that to delete one of them is not to change the essential nature of the contract. However, this cannot on its own be determinative of the substantive question. 
  • It is difficult to predict down which route to the Supreme Court will travel. Perhaps it may prefer a hybrid approach, looking at the matter substantially i.e. would severance change the nature of the contract- giving some weight in this regard to whether the covenants are contained in separate promises? Might it add (an admittedly vague) public policy corrective? 
            5.[2007] IRLR 793   6.[1998] IRLR 388         
  • Prediction is made more difficult because the nature of the severance sought in this case was quite unusual. This was not a case involving the “common garden” type of severance, where words/concepts such as “subsidiaries” or “potential customers” (in addition to “customers”) or “non-dealing” (in addition to “non-solicitation” of customers) are severed because the additional category is too broad. Instead, in Tillman a broadly permissible post-employment “interest in” prohibition needed to be entirely severed, because there should have been excepted from it a nominal (publicly quoted) shareholding. This severance of a largely good covenant seems at odds with cases where the courts will not sever words in a definition which, while curing a “bad” provision, would result in severance of “good” provisions to which the definition also applies.
  • While this approach is distinguishable from the Tillman type of attempted severance, nevertheless consideration of these different types of cases emphasises that what Egon Zehnder were really trying to do was to write into the restrictive covenant a nominal shareholding exception. However, because this would have contravened the “blue-penciling” prohibition against adding (as opposed to deleting) words, Egon Zehnder were required to jettison the whole of the “interest in” part of the covenant. While it is difficult to imagine that a 100% shareholding in a competitor would not come with active engagement (and therefore contravene the valid “engage in” part of the non-compete) the position would not be so clear where the ex-employee took up a substantial but less than 100% shareholding. It is for that reason that employers work from the opposite end of the telescope, excluding from the non-compete only a stated nominal shareholding. It was, of course, the absence of that exclusion which was at the heart of this case.

 (Re-) Drafting in the future 

  • Will the Supreme Court’s decision encourage:
  1. longer clauses, splitting up covenants into ever smaller fragments of sub-clauses and sub-sub clauses?
  2.   the use (and further development) of express severance clauses? While such clauses have often been thought to be no more than reflective of the common law (and in some cases, contrary to the employer’s interests, even having the effect of narrowing the application of the common law severance), if the focus of the Supreme Court decision is whether the parties intended to allow severance, express severance clauses may have a bigger role to play than previously thought.
  3.  (for additional reasons than the usual) putting restrictive covenants in shareholder/vendor agreements, given that in commercial agreements there has been (at least until now) a more generous approach to severance [1]
    7. Ronbar Enterprises v Green [1954] 1 WLR 815 (CA)

  • Interesting Times ahead.




Posted: 08.03.2019 at 09:11
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