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Unintentionally wide non-compete clause: A warning from the Court of Appeal in Egon Zehnder Ltd v Tillman

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Having previously blogged on this case (see here for that blog on Egon Zehnder Ltd v Tillman [2017] EWHC 1278 (Ch)), Jacques Algazy QC and Nathaniel Caiden consider the repercussions of the Court of Appeal judgment in Tillman v Egon Zehnder Ltd [2017] EWCA Civ 1054.

 

Background

The facts of the case are summarised in the previous blog (see here).  In the Court of Appeal, which overturned the High Court’s decision, the focus was on the interpretation of the following covenant and in particular whether the phrase “interested in” including being a shareholder:

13.2 You shall not without the prior written consent of the Company directly or indirectly, either alone or jointly with or on behalf of any third party and whether as principal, manager, employee, contractor, consultant, agent or otherwise howsoever at any time within the period of six months from the Termination Date:

13.2.3 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 such period."

 

The point the Appellant was driving at was clearly acknowledged in the judgment (see [35]);

 a) although she as a matter of fact had no shareholding nor any evidence of wanting to acquire such, she wanted to rely upon this restriction rendering the covenant as a whole, unreasonably wide;

 b) if it was so, the covenant was unenforceable and she could take up employment with the competitor.

 

The Respondent disputed that the clause covered the acquisition of a shareholding at all but conceded that it would be an unreasonable restraint if it did.

Before turning to the legal principles it is also interesting to note that this was the sole ground of appeal, namely that the judge below was wrong to hold that clause 13.2 did not prohibit shareholding (see [10]).  As such the observations of the previous blog (which did not deal with this short argument) appear unaffected by the overturned judgment.

 

Conclusions and legal principles

In approaching the question of construction the Court of Appeal took the following approach in relation to the legal principles (see [12]-[13] and [21]-[25]):

  1. The preference of enforceability to unenforceability can only be invoked if there is genuine ambiguity;
  2. Thus the starting point is the conventional usage of the relevant phrase, if that produced no genuine ambiguity the above principle is inapplicable;
  3. The phrase “interested in” on a conventional usage approach must include holding (any) shares in a company; and
  4. The “anomaly” that, by virtue of clause 4.5 of the contract, during employment one could hold a 5% share, and so the post restrictive covenant seemed to go even further as one was not entitled to any shareholding was of no assistance and it cut both ways anyway. It was equally anomalous for one to be restricted to 5% and then be able to take any size shareholding upon leaving employment.

Having so found, the Respondent sought to sever the offending phrase by ‘blue penciling’ it out.  This was rejected for two reasons ([28]-[34]):

  1. The first, specific to this clause, was that it would still be too wide even if the words “or interested” were omitted, as a shareholding could still be caught by the words “directly or indirectly engage or be concerned… in any business”; and
  2. The second, of more general application, was that parts of a single covenant cannot be severed, it can only be applied to separate covenants and this has not been altered by Beckett Investment Management Group Ltd v Hall [2007] ICR 1539 [37]-[40] which specifically approved the threefold test set out in the earlier case of Sadler v Imperial Life Assurance Company of Canada Ltd [1988] IRLR 388.

The result was that the Appellant succeeded, she was able to join a competitor as the entire covenant was unreasonably, albeit seemingly unintentionally, wide. The covenant would not be enforced. Although in fact there were only a couple of days left on the injunction and the appeal was mainly about the issue of costs; see [35]-[36].

The arguably surprising outcome was explained by the need to defer to wider public policy considerations:

“35 It may be said to be unmeritorious that Ms Tillman can rely on the theoretical width of the post-termination covenant to include a shareholding when she does not intend to acquire any shareholding in any competitor and wants to work for a competitor which she could have been restrained from doing if the clause were more carefully drafted. But the law which avoids contracts in unreasonable restraint of trade is based on the wide public policy. …. In those circumstances the merits of individual cases must inevitably take second place.”

 

Further developments

Some months earlier, the High Court in Tradition Financial Services Ltd v Gamberoni and others [2017] EWHC 768 upheld a covenant couched in similar language.  The Defendants unsuccessfuly argued that the expression “interested in” had to include a shareholding. Tradition was briefly referred to in Tillman [18] with the Court preferring to “leave that case on one side” and observing that it was on its way to the Court of Appeal in any event. It is understood that this particular point is being appealed.

Commentators on Tillman are divided as to the precise impact of the case. One view is that a carve out allowing a limited shareholding, say 5% in listed companies, will pass muster. However, the non-compete may still be considered too wide to be enforceable if the carve out is too narrow. Another view is that no restrictions on arm’s length shareholdings post employment will readily be tolerated by the Courts.

 

Practice points/observations

Three observations flow from this short judgment of the Court of Appeal

(1)  Employees will be encouraged into challenging non-competes and perhaps ‘combing’ through covenants to find unreasonable width even where a wide meaning was not intended.  From analysis of first instance decisions in recent years, it might be argued that hitherto the direction of travel was that the courts were unimpressed with employees seeking to argue that covenants were so wide to be rendered unenforceable.  In the words of this judgment they were perhaps inclined to regard as “unmeritorious” arguments as to “theoretical width”.

(2) The language used in the offending clause is not especially unusual. Many covenants contain a similar prohibition in these precise terms or use similar language. Employers may well seek to recast their post termination restrictions so as not to fall foul of the line drawn by the Court and would be well advised to do so. It would not be surprising to see employers seeking to intoduce new contracts containing freshly drafted covenants accompanied by raises or other forms of suitable consideration.

(3) Drafters of covenants will be keen to adopt a style whereby it is absolutely clear that each part of a covenant is separate.  The result may be a very long document, as paragraphs are separated out into separate sections, so that one can more effectively argue that severance is available.

12 October 2017

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