A welcome clarification on restrictive covenants

Tillman (Employee) v Egon Zehnder Ltd (Employer)

This important UK case will be welcome news to employers. The highest court in the UK has provided some crucial and clear guidance on the use and application of restrictive covenants, an implement often used by organisations to protect their businesses after key employees leave.

The Employee was hired by the Employer in January 2004. The Employer was engaged in executive recruitment. On 23 January 2017 the Employee resigned. One week later, the Employer terminated her employment with immediate effect and made a payment in lieu of notice, in accordance with her contract of employment.

The Employee then informed the Employer she wanted to commence employment with a competitor. The Employer commenced proceedings, suggesting this would be in breach of a six-month non-compete clause contained in the Employee’s contract.

The Employee argued that the non-compete clause was not legally binding as it was wider than reasonably required for the protection of the legitimate business interests of the Employer. In particular, she argued that being “interested” in a competing business was too wide as it could prevent her from having a minor shareholding in a competitor for investment purposes.

Turning to the construction of the clause, the court held that being ‘interested’ in a competing business includes being a shareholder of that business, whether large or small. The non-compete clause was essentially a bar the Employee having anything whatsoever to do with a competitor – even holding a small shareholding as a passive investor. Therefore, the non-compete clause as originally drafted was unreasonably restrictive.

The court then had to deal with the issue of severance (amending a clause to remove the void wording). The court was faced with two differing approaches, found in Attwood v Lamont and Beckett Investment Management Group Ltd v Hall. The court confirmed three pronged test contained in Beckett is the correct test when considering severance:-

1. the first criterion is whether the unenforceable provision is capable of being removed without the necessity of adding to or modifying the wording of what remains, this is the so called “blue pencil” test.

2. the second criterion is that the remaining terms continue to be supported by adequate consideration.

3. the third criterion is that the removal of the unenforceable provision does not generate any major change in the overall effect of the contract.

Applying the above test to the facts of this case, the words “interested in” were capable of being removed from the restrictive covenants without the need to add to or modify the wording of the rest of the clause and removal of the prohibition against the Employee being “interested” would not generate any major change in the overall effect of the restraints. This meant the restriction on the Employee being engaged or concerned in a competing business would remain binding on the Employee minus the prohibition of holding any shares.

Take-away points
1. The starting point remains that such covenants will be void unless they go no further than is necessary to protect the employer’s legitimate business interests (e.g. confidential information or business connections).

2. Well drafted covenants would have a clause in them specifically stating that the restriction did not prevent the employee from holding a shareholding in another company, to remove the suggestion that the clause was too far reaching.

3. The Supreme Court has loosened the severance test significantly. The manner in which employment restrictive covenants are drafted, make it difficult to think of examples where the “no major change” test would prevent severance occurring.

4. The clarification from the court may now mean employers are willing to draft employment restrictive covenants more widely than previously, on the basis that they can still be enforced once they have been severed by the court.

5. One thing employers will need to bear in mind is in relation to costs. The court made reference to the unreasonable aspects of post-employment restrictions as being “legal litter”. The court is implying here it should not be the employee who has to pay the cost of clearing up the “litter”.

6. Restrictive covenants should still only be used in relation to senior employees.

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