In the case of Egon Zehnder v Tillman the Court of Appeal held that a non-compete restrictive covenant in the employment contract of a senior executive was unenforceable, overturning an earlier High Court decision. It should serve as a warning to employers to take real care over the drafting of restrictive covenants, whilst it is likely to have important implications in future cases concerning the enforcement of post termination restrictions.
As is well known, restrictive covenants in employment contracts are enforceable only if the employer can prove that they go no further than reasonably necessary to protect their legitimate business interests, such as their customer or client connections, trade secrets and confidential information, and the stability of their workforce.
Facts of the case
After a successful career in investment banking, Ms Tillman joined a leading executive search firm and signed their standard contract. In addition to non-solicitation, non-dealing and confidentiality provisions, the enforceability of which were not in dispute, the employee’s contract contained a non-compete restrictive covenant:
“You shall not… within the period of six months from the Termination Date … directly or indirectly engage or be concerned or interested in any business carried on in competition with any of the businesses of the Company or any Group Company which were carried on at the Termination Date or during the period of twelve months prior to that date and with which you were materially concerned during such period”.
On the face of it, Ms Tillman joined in an entry-level position. This could have called into question the enforceability of the non-compete clauses in her contract, because the question of reasonableness is judged as at the time the contract was agreed. However, in this case the mutual expectation of the parties was that she would rise quickly through the ranks into a position of seniority. That is exactly what happened: she rapidly achieved promotion and became a “partner” (although in fact she remained an employee for employment status purposes) and global co-head of the financial services practice group.
In January 2017, she announced that she was resigning, and her employment was terminated with pay in lieu of notice. A dispute then arose over the enforceability of her six month non-compete clause in the context of her wish to join a rival head-hunting firm based in New York.
The minor shareholdings argument
The employee argued that her non-compete covenant was too wide to be enforceable as the term “interested in” would cover her holding any minor shareholding in a competitor business, even merely as a passive investment. There was no exception in her contract which expressly stated that she could hold such shareholdings after termination of employment and not be in breach of restrictive covenant.
The employer argued that this was not what the clause was intended to restrict. It relied on another clause in the employment contract, which prohibited the employee from holding or having any interest in shares in competitors during employment, and which contained an exception for minor shareholdings held for investment only. It was said that it would be commercially anomalous if the non-compete clause prohibited all shareholdings in competitors, since then the position post termination would be more restrictive than during employment. Accordingly the employer argued that the term “interested in” was ambiguous, and it relied on the principle that faced with two possible interpretations of a restrictive covenant, the court should prefer the interpretation that validates rather than invalidates the covenant, as the parties should be deemed to have intended their bargain to be lawful and enforceable (the principle of the preference of enforceability over unenforceability).
The Court of Appeal’s decision
Whilst the High Court accepted the employer’s arguments, the Court of appeal did not and overturned the High Court’s decision. It disagreed that the phrase “interested in” a competitor company could be interpreted as excluding holding shares in it and only covering “active participation” in it, as suggested by the employer. The phrase could not be said to be ambiguous, so the principle of the preference of enforceability to unenforceability was inapplicable. On the basis that the non-compete clause prohibited all shareholdings, the Court held that it was impermissibly wide.
That raised the question of whether it could be saved by applying the “blue-pencil” test and deleting the offending words. The judge at first instance did not need to deal with this issue, given his interpretation of the meaning of the covenant, but indicated that if the issue had been relevant then he would have found the argument unappealing. The Court of Appeal agreed, and in doing so it appears to have resolved the question of whether it is permissible to delete only parts of a single covenant in order to render the remainder enforceable:
“it must always be doubtful whether parts of a single covenant can be deleted without the contract becoming ‘not the sort of contract that the parties entered into at all’. It is… no business of the courts to create a valid covenant in order to replace an impermissibly wide covenant which an employer has sought to impose on the employee”.
Further, the Court held that in any event being a shareholder in a company carrying on a business amounts to being “concerned in” that business, at least indirectly.
Implications in practice
It has often been observed in recent years that the environment for enforcing non-compete and other restrictive covenants against employees has overall been reasonably favourable for employers. Whilst there have been various reasons for this, this case may result in renewed emphasis on the rigorous scrutiny of the scope and reasonableness of restrictive covenants, even in cases involving the most senior executives. It is telling that the employee did not have a shareholding in a competitor, nor did she intend to obtain one. However, given the covenant was theoretically too wide, it was found to be unenforceable.
In practice, the “blue-pencil” test, as well as the principle of the preference of enforceability over unenforceability, have frequently been relied on by employers in employee competition disputes. The Court of Appeal’s clear indication that parts of a single covenant cannot be severed, and that the principle of the preference of enforceability over unenforceability only applies in cases of genuine ambiguity as to the scope of restrictive covenants interpreted in accordance with their natural meaning, are likely to have significant implications in future cases.
Broad phrases attempting to restrict employees from being “concerned or interested in any business…” are often found in non-compete restrictive covenants. This case means that they will not be enforceable unless they are qualified by an exception for minor shareholdings. Employers would be well advised to check their covenants to see if they need amendment.
In conclusion, this case emphasises the need for employers to get the drafting right in employment contracts and also demonstrates the ability of employees to challenge the enforcement of restrictive covenants. For further tips on the drafting and enforcement of restrictive covenants, see the following posts on our blog: