To much fanfare and the great excitement of many employment lawyers, the UK Supreme Court recently delivered its first judgment on employment post-termination restrictions for a century, in Tillman v. Egon Zehnder. The court set a new test for determining when overly-broad provisions may be severed, in lieu of striking down an entire restrictive covenant. What was the decision all about and what does it mean for restrictive covenants going forward?
Ms. Tillman was a head-hunter for Egon Zehnder. In her employment contract, she agreed not to “directly or indirectly engage or be concerned or interested in” any competing business for six months (a non-compete) should she leave the firm. She resigned and left in January 2017, and then sought to work for a competitor in May 2017, before the non-compete expired. Her former employer sought to enforce the non-compete and was initially granted an interim injunction in the UK High Court. Tillman argued that the restriction was not enforceable because the words “interested in” prevented her from holding even a small number of shares in a competitor, and it was therefore an unreasonable restraint of trade. As a guiding rule, post-termination restrictions in the UK will be found in restraint of trade (and therefore unenforceable) if they are wider than is reasonably necessary to protect a legitimate business interest of the employer. The Court of Appeal agreed with Tillman and refused to sever the words “interested in,” so set aside the injunction prohibiting her from joining a competitor before the term of the non-compete expired.
The Supreme Court decision and its impact on employers
Following its Court of Appeal defeat, the former employer appealed to the UK Supreme Court. The Supreme Court accepted that the words “interested in” were unenforceable but held that they could be struck out or “severed” from the rest of the non-compete clause, so that the non-compete became enforceable. In short, the former employer won. The Supreme Court held that there are three criteria to meet in order for severance to be possible:
- The so-called “blue pencil” test – a court must be able to remove the offending words without needing to add to or modify the remainder of the covenant.
- What remains of the agreement must continue to be supported by adequate consideration.
- The removal of the offending provision must not generate any major change in the overall effect of the post-termination restrictions for the contract. Moreover, it is for the employer to prove this element. This third prong is a new step in the analysis.
Employers that use post-termination restrictions should take note of this reformulated test, as courts will now use these criteria when evaluating possible severance of words within restrictions.
What this decision means for employers
In this case, the Supreme Court accepted that the words “interested in” included in a non-compete restriction on a former employee were unenforceable (as they prevented her from simply holding a few shares in a competitor), but held that they could be struck out or “severed” from the rest of the non-compete clause, so that the term became enforceable.
There are a few takeaways from this decision for employers:
- This decision may open the doors to more employers trying to enforce restrictions that have a couple of words that may be deemed too broad, on the basis that they can be severed.
- Although the Supreme Court did sever the problematic words in the restriction in this case, employers should consider whether it makes sense to expressly carve out minority or passive shareholdings from post-employment restrictions.
- The addition of the third element in the severance analysis raises the question of what it means to “generate a major change” in the overall effect of the restrictive covenant, by removing a few words. What constitutes a “major change” is a point that we expect to see developed in future case law.
- While employers may be emboldened by this ruling, they should bear in mind that the Supreme Court has left open which party should pick up the costs when an employer successfully persuades a court to sever certain words from a restriction in order to make it enforceable. The court suggested that the employer may be obligated to cover some or all of the legal costs for failing to draft its restrictive covenant appropriately in the first place (although it has yet to decide who should pay the costs in this case). As a result, employers should continue to proceed carefully when drafting post-termination restrictions. Employers should also consider reviewing the scope of their agreements periodically and, ideally, may not have to rely on a severance argument should the need to enforce arise.