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Employment

A win for employers – but with a sting in the tail

The Supreme Court has handed down its long awaited decision in the case of Tillman v Egon Zehnder, the first employment restrictive covenant case to be considered by the highest court in the land for over a century. The decision is good news for employers who want to enforce restrictions on departing employees’ competitive activities, but nevertheless serves as a timely reminder of the importance of getting the contractual wording right in order to do so.

What was the case about?

It has long been established that post-termination restrictive covenants will only be enforceable if the employer can show that they go no further than is reasonable to protect its legitimate business interests.

In the current case, the employee’s contract prohibited her from being “engaged, concerned or interested in” a competitive business for a period after leaving her employer. Following her employment she wanted to join a competitor.

The dispute centred on the words “interested in”, with the employee arguing that this prevented her from holding even a small passive shareholding in a competitive business – as such the whole covenant was too wide and should not be enforced. It was irrelevant that she never intended to acquire a shareholding.

The Supreme Court agreed, to a point. It acknowledged that “interested in” can encompass a minority shareholding and that for an employer to prevent an employee from acquiring such a shareholding post termination was an unreasonable restraint of trade.

However, it then went on to consider the second part of the case, namely whether the offending words could be severed from the rest of the covenant so as to leave the remainder enforceable. The Court of Appeal had decided that it could not, applying a strict approach to severance.

What did the Supreme Court say about severance?

The Supreme Court examined a whole raft of previous cases on severance and arrived at a more flexible, employer friendly, three stage approach.

First, confirming the “blue pencil” test, where a court is permitted to remove words but not add to or modify the remainder, it held that the words “or interested” were capable of being removed as the sentence would continue to make sense without them.

Second, highlighting that the remaining terms must continue to be supported by adequate consideration, it indicated that in the “usual situation”, including in the current case, this second requirement will easily be satisfied and can be ignored.   

Third, referring to the criterion (expressed as “crucial” by the Court) that removal of the offending words should not generate any major change in the overall legal effect of the covenants, it held that this part of the test was also satisfied and that the words should be severed.

Once severed, the balance of the non-compete restriction was enforceable against the employee.

What will the decision mean for employers?

This was ultimately an important victory for the employer in this case, and for other employers intent on enforcing covenants that may contain unenforceable parts. However, it has also highlighted the importance of careful drafting. Employers are advised to review their restrictive covenants to ensure that:

  • they contain the appropriate carve outs for minority shareholdings;
  • where there is a risk that some part of the restriction is too wide, that that part is severable, applying the test set out by the Supreme Court; and
  • the restrictions otherwise go no further than reasonable to protect the employer’s legitimate interests.

Despite the successful severance in this instance, the Court acknowledged that other than in some situations involving high-ranking employees, the parties are unlikely to be on an equal footing and the courts must continue to adopt a cautious approach to the severance of post-employment restraints. It should therefore not be assumed that a court will come to the assistance of an employer who have included, even unwittingly, unenforceable parts in a restriction.

In addition, the Court endorsed the view expressed in another case that severed parts of covenants are “legal litter” casting an unfair burden on others to clear it up. The “sting in the tail” for the employer in this case may well be reflected in the assessment of the costs incurred in this long-running litigation.

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