Restrictive covenants are a key tool for organisations to protect the business when an employee leaves. However, it is vital the drafting goes no further than reasonably necessary to protect a legitimate business interest. If they are drafted too widely, they are unenforceable. We discuss the landmark case of Tillman v Egon Zehnder and the practical implications for drafting and enforcing restrictive covenants.
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Siobhan Bishop: Hello and welcome to our podcast where we are discussing what is one of the most important cases of the year and what is definitely a landmark case on restrictive covenants. So in this podcast we're going to be focussing on the Supreme Court's decision in Tillman & Egon Zehnder and what it means for restrictive covenants, both drafting them and the practical implications of that decision.
I'm Siobhan Bishop, a Principal Associate in the Employment, Labour & Equalities Team here at Gowling WLG and I'm joined by Martin Chitty, a Partner in the Team.
So this case is seen as good news for employers relying on restrictive covenants and it will make it harder for employees to argue that they are unenforceable, even where they may be too wide on the face of it.
Just going back to first principles, as a matter of public policy, restrictive covenants (or post termination restrictions) are an unlawful restraint of trade. However, they will be enforced and valid in certain circumstances - if they protect a legitimate business interest to a reasonable extent. The interest is about typically confidential information or what is known as "goodwill" - so customer or staff connections - and what is reasonable will all depend on the seniority of the individual, what is reasonable in those circumstances and in a particular market. The Court can also, in some cases, "blue pencil" a certain provision in a contract which essentially means editing it in some way by crossing out the offending part and removing those terms which are excessive and will enforce the remaining part of the clause.
However, the Court will not do this in every case and generally the Court will not reduce or redraft a clause to make it work. So it's very important that these clauses are drafted carefully and are bespoke to a particular individual and the particular market in which they work, so that the organisation ultimately is properly protected.
Martin Chitty: Well, Ms Tillman joined Zehnder in 2004. She was in the words of the Court seen as "a bit special". She came in on a high salary, guaranteed bonus and overtime, some time later she became a partner in the business and in her contact were, if you like, the standard suite of restrictions. There were restrictions on solicitation of customers and other people and then there was a very broad prohibition on her going to work for a competitor and that became important because in 2017 she was poached by a competitor in the market.
So, she gave notice, she made it clear that she was going to abide by the terms of her contract going forward with the one exception of the fact that she was going to go and work for the competitor. She said that provision is not enforceable. Discussions took place, didn't reach a conclusion and it became unavoidable that Zehnder commenced litigation.
Actually they got on with the litigation really quickly because they issued proceedings on 10 April. They got into Court on 15 May 2017. The initial hearing upheld the restrictions in their favour. Ms Tillman appealed because she now found that she couldn't go and work for her new employers, and that was heard in the Court of Appeal on 21 July, so just over two months later. Now, that may not sound particularly quick but in the way in which these things evolve, it is actually rocket-assisted.
Siobhan: And the key clause in the contract was Ms Tillman's post termination non-competition clause – which essentially said that - for 6 months after she left employment she would not:
"directly or indirectly engage or be concerned or interested in any business in competition with Egon Zehnder..."
The clause also applied to businesses in competition with any Group Company and there were some limitations such as it only applied to businesses which were carried on at the Termination Date or during the period of 12 months prior to that date and with which Ms Tillman was materially concerned during that period.
But what did having an "interest in" a competitor actually mean? Ms Tillman said that it prevented her holding even a very small shareholding in a competing business (such as one share in a publically quoted company) and that made the clause too wide and as a result it was "in restraint of trade" because it went further than necessary to protect the legitimate business interest of Egon Zehnder. If that was right, the post termination non-competition clause would be unenforceable in its entirety unless those words "interested in" could be removed from the clause under the "principle of severance" leaving the remainder of the clause enforceable.
Ms Tillman argued that the offending words could not be severed and even though she did not intend to hold a shareholding in a competitor, she could work for one because that covenant was unenforceable.
It's also worth noting that in this case there was a separate clause in the contract which related to restrictions during her employment. And that clause prevented Ms Tillman from being interested in a competitor during her employment. However, unlike the post termination non-competition clause, it had an exception to it. During her employment, she could hold a minority shareholding, for investment only, of up to 5% in a publicly quoted company.
And of course, the post-termination restriction did not have this type of minority shareholding exception. So, what happened?
Zehnder then lost in the Court of Appeal and the Court concluded that the restriction which prohibited her having any interest after employment, when it had been permitted before termination, was unreasonable. It did not matter whether she had ever intended to buy any shares in a competitor at all and on that basis the clause was defective and so was not enforceable at all. One of the key points was that the Court concluded that it could not simply take out those offending words and leave the rest of the clause on its own and enforceable. And so, Martin, we then moved onto the Supreme Court where the appeal was based on two reasons.
Martin: Yes, that's right. In the circumstances Zehnder had little alternative because they had decided to take the fight to Ms Tillman and they had lost in the Court of Appeal, so the only way of restricting it was to go further.
Their argument was two basic points, but actually the first one is split into two parts. They went for a really big question as the first part which is the restriction on which they wanted to rely isn't subject at all to the doctrine and the philosophy of "restraint of trade", which you talked about earlier, and in fact therefore the Court shouldn't be thinking about "restraint of trade" because it was irrelevant, they should just allow it to stay in place. And it's fair to say the Supreme Court dismissed that very quickly and gave it very short shrift.
So that left them with the question of whether a restriction on being "interested" in a competitor, what did that mean and how did it work in practice? In fact they'd managed to review, in a relatively detailed way, something like 600 years of case law over a very short period of time. They've concluded that that sort of restriction equates with having a shareholding in a competitor is competition and on that basis it was caught by the doctrine, but the restriction was too wide, because when she entered into the restriction in 2004 it was beyond what was necessary to protect their interest to a reasonable extent. So that one got thrown out.
Siobhan: So this is good news for employers for a number of reasons. Well drafted contracts will have a small shareholding exception anyway, allowing an employee to hold a limited number of shares. But for current contracts of employment that don't have that exception, there may be a lifeline as a result of this case because they may well still be enforceable if they prevent the employee from being interested in another business if that part of the clause can be severed. However, this case does not mean that that will always be the case because the general rule is still valid and that general rule is that contractual restraints on a former employee's freedom to work are generally void and unenforceable, as being in restraint of trade and contrary to the public policy point we talked about, unless they are no wider than necessary to protect the legitimate business interest for a reasonable period. So you will still need to be checking the wording of the carve-out of the restriction and that it includes having an interest in another business and that is wide enough, but also the "blue pencil" test isn't always going to be that lifeline because it depends on the whole clause and how that is drafted.
Martin: Yes, that's right. The Court are able to sever any unenforceable words, as they have done in the Tillman case, but what they can't do is re-write them, so if what you're left with makes no sense, and that's probably the more important point rather than it changing somehow the bargain the parties originally made, they won't enforce it. Similarly, they won't imply restrictions, they won't imply wordings into the clauses, generally speaking, in order to make them valid and absolutely what they will not do is change the terms. So if, for instance, the Court decides that a 12 months restriction is too much but a 3 month restriction would have been enough, they won't simply substitute one for the other, that's not the use of a "blue pencil". Blue pencil simply takes something out, so employers still have to be wary about all of that and our advice would be consider your standard form contracts, think carefully before you look to enforce them, because although it might be more attractive to pursue people after they've left and a bit easier, it's not necessarily without its risks.
The other point to think about, and this is a problem which the Tillman case also highlights in the Supreme Court Judgment. When Ms Tillman was promoted, and as she was several times, ultimately when she became a partner which is a grade in the business, she wasn't given a new contract, so she had only got the contract she had when she first joined. Now ultimately that might not have made any difference, because there was nothing to suggest that they would have changed the way in which they drafted the agreements, but as a general principle these restrictions are judged by their enforceability when they are entered into and what's reasonable when you are a director, is something quite different to what might be regarded as reasonable when you joined the company as a trainee, for instance. So employers need to keep their eyes on that over time, as there is a constant need for review.
Siobhan: So where do we think this case leaves us now? Obviously there is good news, on the face of it. Do you think there will be other consequences, such as potentially encouraging employers to be more aggressive in their drafting, potentially including wider clauses in anticipation that if the employee challenges them, the Courts may apply a "blue pencil" test to any parts that are seen as invalid and remove those offending parts, leaving the rest enforceable?
Martin: I think that's highly likely, to be perfectly honest. Whether we describe it as "aggressive" or not I don't know whether that's quite the right language. What we have seen over time, when these issues have come up before is a stylistic change. So rather than having one single clause with lots and lots of restrictions in it, what tends to happen is that you identify a period of restraint and then have all the various elements of it hanging off in lots of separate sub-clauses, and that makes it relatively easy, you would hope, that the Judge when they're looking to enforce it just to skim down the list and go "Ok, Ok, Ok, don't like that one, can put a blue pencil through it" but it doesn't alter the sense of the clause because each sub-element is separate.
There's a second interesting point in here as well which the Supreme Court mentioned right on the very last line of the Judgment. And what they've said, picking up on some language used in earlier cases is this, that if employers haven't sorted themselves out and they come to Court and ask the Court to sort out what was described as their "legal litter", then they must expect that the Court may well look at that in terms of whether they get their costs back or not and listeners will know that costs normally follow the event, so if you win in these circumstances you get your costs back from the errant employee. But here they seem to be suggesting, if you've made a mess of this, if you have been inattentive and you ask us to sort it out, we are going to penalise you in costs. And that creates a very real commercial decision to be made by the employer. You know that you may be able to enforce it, even though it is imperfect, because you expect the Court actually to "blue pencil" the ineffective or excessive elements of it, but question how much are you going to pay? You may not need to go to the Supreme Court. I think what we will see is employers being more robust in terms of pursing the applications at the first instance, but it may mean that they don't get their costs back. So you get what you want but at a price. So commercially do you decide – where do you spend the money? Do you spend the money in trying to restrict someone from moving and going to the new competitor and stealing business from you, or do you invest your money in getting out there and getting in the faces of the clients? What do you invest it in, accepting that well, we won't bother this time, we'll just get better contracts in place going forward.
Siobhan: So if you're going through the latter of those approaches, it's really important to focus on what you actually need to protect at the beginning and to keep that under review as you mentioned before.
Martin: Yes, that's absolutely right. And one of the things we learn over time when we are trying to enforce these restrictions is you have to explain to the Court why the clause does what it tries to do. Why is it 12 months rather than 6 or 3, or 9 or 24? What is it about your business and the business cycle that requires that level of restriction? Why should it only apply, for instance, to people you've dealt with in the preceding 24 months. You do need it to apply to people you've dealt with, or the individual has dealt with, personally. But why that period of retrospection rather than any other period? And it's useful to have had that in mind when you are actually drafting the contract in the first place. Now, I'm not going to say that employers should put a note on the file saying "we did this because" but it would be very helpful to show what was in their mind at the time the contract was entered into, because that's what they're being asked to explain.
Siobhan: So, it's always best to consider what restrictions are needed and that they don't go further than reasonably necessary to protect a legitimate business interest, for example, ensuring the activities the time and area of the restriction are appropriately limited.
On the facts of Ms Tillman's case, even though the words did go too far, the words "or interested" were capable of being removed from the post termination non-compete clause. And following this case, we have clear authority for the criterion the court will apply to see whether any wording can be severed. So, for example, in this case, firstly, there was no need to add to or modify the wording of the rest of the clause - the clause still made sense even if you deleted the wording about being "interested in" a competitor. And secondly, removing the wording about being "interested in" a competitor did not generate any major change in the overall effect of the post termination restraints.
So, even though the clause was too wide, because Ms Tillman should have been allowed to hold a minor shareholding for investment purposes, if she had wished, the offending words (being the words "interested in") could be removed and she was bound by the rest of the non-compete clause.
Of course, the severance principle test will not always help save a restriction that is too wide as it will depend on the particular drafting and the employer has to show the test for severance is met. It may be better not to be too greedy because even if the court is prepared to sever the unenforceable part of the covenant, and bearing in mind the court will be cautious in its approach, as Martin mentioned, the costs of enforcing the reminder of a badly drafted clause may be too high.
So, thank you very much, Martin. If you have any questions or concerns on restrictive covenants and how to protect your organisation when an employee leaves, please do get in touch with Martin or any member of the team. Thank you.
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