The first Supreme Court judgment on employment competition in a century was handed down recently – and it is good news for employers.
In Tillman v Egon Zehnder the Court of Appeal appeared to have dealt a fatal blow to a non-competition restriction prohibiting Ms Tillman from being “interested in” businesses competitive with her employer for a period post-termination on the basis that – absent an express carve-out – this prohibited even a minor shareholding in a competitor, and was therefore an unreasonable restraint of trade, especially because her contract allowed such a holding during her employment. However, the life of the covenant was saved by some amputative surgery in the Supreme Court, which held that the words “interested in” could be severed from the clause, leaving the remainder of the restriction bleeding but intact.
Lord Justice Wilson’s judgment (which cited cases spanning six centuries and involving such disparate figures as the footballer Wayne Rooney, actress Bette Davis, and a marginally less well-known 17th century haberdasher) noted that the phrase “engaged or concerned or interested” had been included in standard precedents throughout the last century. The decision therefore means that the significant number of employers whose employment contracts contain non-competition clauses with this very common wording will not be precluded from enforcing these covenants against employees in breach (provided the restrictions are otherwise reasonable). And it potentially has even further-reaching impact, meaning as it does that other impermissibly onerous provisions of otherwise reasonable restrictive covenants may also be severed to leave the remaining clause enforceable.
However, is important to note that courts do not have carte blanche to re-write unenforceable restrictive covenants. The unenforceable provision must be capable of being removed without the necessity of adding to or modifying the wording of the remainder of the clause. Severance must also not generate any major change in the overall effect of all of the post-employment restraints in the contract. Surgery, yes, but reconstructive surgery, no.
Employers should bear in mind that the starting point is that all post-termination restraints are unenforceable on the public policy ground that they restrain trade. Courts will deviate from this principle only where restrictions are drafted no more widely than “reasonably necessary” to protect the employer’s legitimate business interests – typically confidential information, trade connections and/or the stability of the workforce. Covenants which preclude even a small minority shareholding in a competitor are likely to be impermissibly wide, and so express carve-outs permitting such holdings should be included.
However, employers may (entirely legitimately) wish to prohibit employees – particularly C-suite or senior executives – from acquiring a significant shareholding in a competitor. This begs the question of what level of shareholding should be permitted to ensure the prohibition against a material shareholding is enforceable. Restrictions prohibiting employees from being “interested in” a competitor with a carve-out for 3% or 5% shareholdings in public companies are both common and frequently held to be enforceable.
But the extent of these carve-outs often appears to be somewhat arbitrary. Why should a restriction prohibiting a shareholding of, say, 2%, in a competitor be considered no wider than reasonably necessary to protect the employer’s legitimate interests, whereas a covenant precluding a shareholding of 6% be an impermissible restraint of trade? Why should a restriction which prohibits an employee from acquiring even a single share in a competitor be considered reasonable simply because that competitor is a private limited company?
It seems possible that the scope of such carve-outs could be subject to challenge in future litigation. On that basis, employers which do wish to prevent employees from holding shares in a competitor should be seen to think carefully about the extent of the prohibition and any carve-out. Surely, as for the geographical scope or duration or range of prohibited activities, the employer ought to be seen to consider the specific necessity for the extent of each restriction? There is a degree of “wriggle-room” implicit in “reasonably necessary”, which should avoid arguments about should it be 2% or 3%, but does that matter if you can’t show either of them to be necessary at all? If I could hold 10% of a company’s shares without being able to influence it or be influenced by it, why should 2 or 3 or 5% be enforceable? Restrictions precluding employees from acquiring a clearly controlling or influencing interest will be much more likely to be enforceable, but may then offer insufficient protection to employers. Tillman may have struck a blow for employers in the short term but it is far from clear that the competitive shareholding question has had its last outing in the Courts.
Regardless, employers would be well-advised to review their covenants to ensure that any potentially unenforceable provisions can be cleanly severed without proving fatal to the restriction. If not, it may be sensible to offer key employees a new suite of covenants at their next salary review, making any raise conditional upon their signing a contractual variation.