Restrictive covenants and blue pencils

27 August 2019

Rating system:
Reading time (1-10 minutes): 4ish
Sophistication level (1 (idiot) – 10 (expert)): 6
Entertainment value (1 (turgid) – 10 (side-splitting)): 4

Background

In July this year, for the first time in over 100 years a case on post-employment restrictive covenants reached the Supreme Court. I reported on the Court of Appeal decision in this case in July 2017. Feel free to have a look at this if you want a bit more background and detail. As recommended by me (lol), the Supreme Court has overruled the Court of Appeal’s decision.

Many employment contracts have restrictive covenant clauses which are aimed to stop the employee being involved with a competitor for a period of time after their employment ends. These can be hard to word in a way which will make them enforceable. When courts look at such clauses the balance of protecting each side’s interests weighs heavily against the employer. There is quite a strong legal principle which says that restrictive covenants will be void on public policy grounds as a restraint of trade unless they go no further than is reasonably necessary to protect the employer’s legitimate business interests at the time the contract was entered into.

Recognised ‘legitimate business interests’ include the need to protect confidential information, client connections and workforce stability. The reasonableness of restrictions might depend for example on their length, the definition of the business to be protected, and on geographical scope. More generalised restrictions such as simply not to get involved with ‘competing’ businesses need to be particularly carefully worded.

The blue pencil rule

Certain rules of interpretation have developed over the years. One of these is the doctrine of severance, also known as the ‘blue pencil’ rule, which says that if a clause as worded is unenforceable but would have been enforceable if some particular words were removed, then you can simply remove those words. Otherwise, even if a clause is mostly reasonable but just one small part of it is held to be unenforceable then the whole clause has to be struck out. The doctrine of severance is a general contract law thing. But over the last century or so (particularly a big Court of Appeal case back in 1920!) courts have become less likely to agree to use it to help employers in restrictive covenant cases. For example, they said the rule could only be applied where the clause really amounted to separate restrictive covenants, one of which was unfair. This is why restrictive covenants in all sorts of contracts nowadays break things up into different sub-clauses –for example one sub-clause saying you can’t take on any of your ex-employer’s clients (even if they want to come to you without you asking), and another saying you can’t actively solicit those clients. The former may not be enforceable but if so the blue pencil can be applied to it so the latter can still be enforceable. (For a bit more on this see this other article I wrote.)

Recent case

Egon Zehnder (‘EZ’) is a global executive search and recruitment business. It recruited a high-flyer, Mary-Caroline Tillman, in 2004. She flew up the ladder and became the joint global head of their financial services practice.

Her employment contract contained a number of restrictive covenants, one of which said that for six months after her employment ended she would 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…“

This is very standard wording. It is often accompanied by a proviso saying that you won’t be in breach just because you have a small investment in a quoted company which happens to be competitive – the thinking behind this being that the covenant might otherwise be too broad to be enforceable. In this case there was no such proviso.

Just in case you’re interested, ‘interested in’ in this context means having some form of commercial interest in something, eg shares. It doesn’t mean you are not allowed to find something interesting…

And in case you’re interested, “concerned” in this context is generally taken as meaning working for the business or having some other active involvement in it. It doesn’t mean you are not allowed to be worried about it…

On 30 January 2017 Ms Tillman left EZ and told them she planned to join a competitor, Russell Reynolds Associates, 3 months later on 1 May.

The Court of Appeal had agreed with Ms Tillman’s argument that the whole of the restrictive covenant clause was unenforceable, because there was no proviso letting her hold shares in a small quoted company for investment purposes and therefore as worded it was too broad, even though it was irrelevant to what she was actually proposing to do here – ie go and work for a competitor.

The Court of Appeal also refused to sever the words ‘or interested’ so that the clause would have read “directly or indirectly engage or be concerned in any business carried on in competition with any of the businesses of the company” – which would then have been reasonable and enforceable.

What did the Supreme Court decide?

The Supreme Court agreed with the Court of Appeal that the restrictive covenant clause as drafted was unenforceable.

BUT it DID allow the words ‘or interested’ to be severed from the contract. It said that from now on the main criteria in deciding whether to apply the blue pencil rule should be:

• That the unenforceable provision can be removed without adding to or modifying the remaining wording; and
• That the removal of the unenforceable provision shouldn’t generate any major change to the overall effect of all the post-termination restrictions in the contract.

Although the Supreme Court was prepared to use the blue pencil test to help out the employer, it said the employer still had to pay a significant part of the legal costs of the case, as it should have worded its restrictive covenants better in the first place so that it didn’t have to go to court with this ‘legal litter’ for the court to clear up.

Comments and tips

Whilst life may have become a bit easier for employers in the world of enforcing restrictive covenants, best advice is still to be very careful how you word your restrictive covenants, to ensure that they are carefully worded and go no further in any respect than they need to go to protect the employer’s legitimate business interests at the time the contract is entered into.

Note the words ‘at the time the contract is entered into’. As employees become more senior their employers should revisit their employment contracts to see whether more appropriate restrictive covenants should be sought.

It’s not clear to me how pedantic employers now need to be in their drafting to improve their chances of a court applying the blue pencil. For example, if the clause in this case had instead said that Ms Tillman should not “directly or indirectly engage, be concerned or be interested in any business carried on in competition with any of the businesses of the company…“ would a court feel it could use the blue pencil test? Taking out the words ‘or be interested’ would leave the words ‘directly or indirectly engage, be concerned in any business…’ Which doesn’t make sense because there is a comma instead of the word ‘or’. Might a court instead have to be asked to remove the words ‘,be concerned or be interested’ so it just left the words ‘directly or indirectly engage in…’? I don’t know the answer… [NB you may want to read my fascinating article in 2016 about the importance of commas…]

Case: Tillman v Egon Zehnder Ltd [2019] UKSC 32