Supreme Court gives significant decision on restrictive covenants

Restrictive covenants are a useful tool for employers to protect their competitive edge and to reduce the risk of ‘star employees’ leaving to join competitors. However, failure to draft restrictive covenants carefully can leave both employer and employee in limbo. Inadequately drafted clauses risk being deemed to be too wide when in fact the original intention of the clause was much narrower.

In the recent case of Tillman v Egon Zehnder, (2019 UKSC 32) the Supreme Court made an important decision in respect of the severance of restrictive covenants and employers are the ones likely to benefit.

Facts of the case

Egon Zehnder Ltd is an executive level headhunter business which is part of an international group of companies. Ms Tillman was employed by Egon Zehnder from 5 January 2004 until 30 January 2017 when her employment was terminated. Ms Tillman’s contract of employment with Egon Zehnder contained restrictive covenants. Clause 13.2.3 restricted Ms Tillman from being directly or indirectly engaged or concerned or interested in any business carried on in competition with Egon Zehnder or a group company at any time within the period of six months from the Termination Date.

Following termination, Ms Tillman wanted to start working for a competitor, Russell Reynolds Associates (RRA). Ms Tillman considered that she was able to do this because clause 13.2.3 was unreasonably wide (and therefore unenforceable), not on the basis that it would prevent her entering employment with RRA, but because it would prohibit her from gaining a minority shareholding in RRA which she would have been permitted to do during the course of her employment with the company.

Egon Zehnder applied to the High Court for an injunction to prevent Ms Tillman from starting employment with RRA.

The decision of the lower courts

In June 2017 the High Court upheld the non-compete restriction in Ms Tillman’s contract and granted an injunction to prevent her from starting employment at RRA. The court held that clause 13.2.3 of the contract did not prohibit Ms Tillman from holding a minor shareholding in a competitor for investment purposes. This conclusion was reached because the court considered that the wording “directly or indirectly … interested in any business” was ambiguous and therefore it could not be said that the restrictive covenant was unreasonably wide. Ms Tillman appealed the decision against her on grounds that the Judge was incorrect in his interpretation of clause 13.2.3.

The Court of Appeal upheld the appeal and reversed the earlier decision. The Court ruled that the word “interested” in clause 13.2.3 did prevent Ms Tillman from owning a shareholding in a competitor company and that this was unreasonably wide; as a result the restrictive covenant was void and unenforceable meaning that Ms Tillman could take up employment with RRA within 6 months of the Termination Date. Egon Zehnder applied for permission to appeal to the Supreme Court.

The Supreme Court decision

The Supreme Court allowed the appeal, overturning the decision of the Court of Appeal that the restrictive covenant was unenforceable. In coming to its decision the Supreme Court considered three strands of the argument:

1. Did the restraint of trade doctrine apply to a prohibition against holding shares?
2. Did the words “interested in” include holding shares in a company?
3. Was it possible to sever the words “interested in” from the clause?

The first argument had not previously been raised by Egon Zehnder, however, the Supreme Court found that the restraint of trade doctrine did apply to holding shares in a company. Turning to the second limb, the Supreme Court agreed with the Court of Appeal that the words “interested in” did cover a shareholding, even if this was minor, and as a result was regarded as too wide.

Moving on to the final point, severance, the Supreme Court disagreed with the Court of Appeal, concluding that the law did not prevent words within a covenant from being severed. The Supreme Court preferred the decision in the case of Beckett Investment Management Group Ltd v Hall as opposed to that of Attwood v Lamont (which was overruled). Under the Beckett approach a three stage test should be applied:

1. Is the unenforceable provision capable of being removed without it being necessary to add to or modify the wording of what remains?
2. Do the remaining terms continue to be supported by adequate consideration? This will not normally be in dispute.
3. Does the removal of the unenforceable provision change the nature of the contact to the extent that it becomes different to the sort of contract the parties entered into?

The third element of this test was deemed to be the most significant by the Supreme Court, however it was determined to be better expressed as “whether removal of the provision would not generate any major change in the overall effect of all the post-employment restraints in the contract” and it was held that this is for the employer to determine.

On the application of the approach set out above dealing with severance, the Supreme Court held that the wording “or interested in” could be removed without having any of the above effects.

The result of the analysis by the Supreme Court meant that the restrictive covenant in Ms Tillman’s contract, once the words “or interested in” were removed, was enforceable by Egon Zehnder and would have prevented her from working for RRA for the six months following the Termination Date.

Implications of the decision

The decision of the Supreme Court is a beneficial one for employers, allowing them to argue that elements of restrictive covenants should be observed even if the restriction in its original form was too wide to be enforceable. This potentially provides employers with the opportunity to correct any previous inadequate drafting at the time of enforcement and to try and push for wider restrictions in the agreement initially.  However, this comes with a note of caution because the Supreme Court set out a three stage test to be passed in order for the words to be removed. It is therefore still important for restrictive covenants to be drafted carefully and tailored to specific roles to avoid any potential discrepancies.