LawFlash

UK Supreme Court Overturns Longstanding Guidance on Severance in Post-Termination Restrictions

July 09, 2019

The UK Supreme Court on July 3 issued its judgment in Tillman v Egon Zehnder Ltd, reversing the decision of the Court of Appeal and permitting the severance of a noncompete covenant, which prevented an employee from acquiring a shareholding in a competitor notwithstanding the size of her interest. More importantly, the decision highlights the willingness and ability of the courts to exercise greater discretion in order to “rescue” restrictive covenants with far-reaching parameters, otherwise perceived as unenforceable.

The Facts

Mary-Caroline Tillman (Tillman), employed as Global Head of Financial Services from 2012 at management consultancy and executive recruitment firm Egon Zehnder Ltd (Egon), departed for competitor Russel Reynolds Associates (Russel) following the end of her employment with Egon on 30 January 2017. Tillman made clear her intention to comply with a number of post-termination restrictions in her contract of employment, apart from a noncompete clause designed to prevent her from seeking employment with a direct competitor for a period of six months after termination. Tillman contended clause 13.2.3 of her contract of employment constituted an unreasonable restraint of trade and therefore should be unenforceable. Clause 13.2.3 stated Tillman should 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 you were materially concerned during such period.

Upon her resignation, Tillman contended that the phrase “interested in” prevented her from even holding a minority shareholding in a competitor firm. In doing so, she argued that the restrictive covenant was unusually wide and was drafted to protect Egon’s interests in the widest form possible. She submitted that the covenant be rendered void as an unreasonable restraint of trade. Egon, on application to the High Court, was successful in obtaining an interim injunction, arguing “interested in” did not prevent Tillman from holding a minority shareholding in a competing business. The High Court refused to reach a view on the question of severance despite Egon’s argument that in the event clause 13.2.3 was interpreted as preventing Tillman from holding a minority shareholding in a competitor, the phrase “interested in” could be severed from the remaining covenant.

To the contrary, the Court of Appeal upheld Tillman’s appeal, ruling “interested in” prevented even a minor shareholding and was therefore impermissibly wide and in restraint of trade. The Court of Appeal also held that severance was not permissible by virtue of the Attwood v Lamont approach. The noncompete restrictive covenant was unenforceable in its entirety.

Egon appealed to the Supreme Court.

The Judgment

The Supreme Court overturned the decision of the Court of Appeal and considered three key issues in reaching its judgment.

  1. The first issue was the application and scope of the restraint of trade doctrine.

    Egon contended that the doctrine of restraint of trade did not apply to a prohibition against holding a shareholding in a competing business. The Supreme Court, in rejecting the notion, took the view that the restraint on shareholding was part of the restraint on Tillman’s ability to work post-termination. The facts fell within the scope of the doctrine.

  2. The second issue was whether “interested in” prohibited a shareholding in a competing business regardless of the size of interest.

    Egon contended that “interested in” did not extend to capture a shareholding. The Supreme Court decided that the natural and proper construction of the words “interested in”, consistent with the longstanding practice of including such language in standard drafting precedents of noncompete covenants, covered a shareholding. The natural meaning of the word applied, and the restrictive covenant, was deemed an unreasonable restraint of trade.

  3. The third and most important issue was whether the overly restrictive covenant could be “severed” by the Court to allow the rest to be enforced.

    In agreeing with Egon, the Supreme Court established a new three-stage test for the severance of noncompete covenants:
  1. Is the unenforceable provision capable “of being removed without the necessity of adding to or modifying the wording of what remains”?
  2. Do “the remaining terms continue to be supported by adequate consideration”?
  3. Would the removal of the provision “generate any major change in the overall effect of all the post-employment restraints in the contract”? (the Final Limb)

The Supreme Court ruled that the phrase “interested in” was capable of being severed and removed without the need to modify the remaining language of the overly restrictive covenant. Similarly, removal of the prohibition would not in itself reflect any major change in the overall effect of the restraints.

Navigating the Post-Tillman Era

The Supreme Court’s guidance on when a court should be prepared to amend restrictions so that they are enforceable is helpful for employers.

That said, the general principle remains that the courts will not rewrite restrictive covenants in order to make unreasonably drafted covenants more reasonable so that they are enforceable. Accordingly, employers should review and update their restrictions in light of the Supreme Court’s conclusions on the inclusion of the “interested in” language. For existing key employees, there will be a need to consider whether it is prudent to obtain their express written consent in amending their employment contracts and if so, how and when to do so. In some circumstances, this may be a useful exercise even when an employer believes such consent will not be forthcoming from all employees in that this may flush out potential areas of risks to the business.

While it may be tempting for employers to take a more aggressive approach from a tactical perspective when drafting restrictive covenants, this is likely to be high risk in most situations. The third limb of the three-fold test identified above is also likely to be subject to further debate and litigation before the courts in the coming years.

Finally, it is worth noting that employers should not necessarily expect to recover their costs (or all of them) if they win in circumstances where the Court has been asked to utilise its blue pencil in removing overly restrictive covenants. As the Supreme Court puts it, “there may be a sting in the tail” when it comes to costs.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

London
Matthew Howse
Lee Harding
Louise Skinner
Pulina Whitaker