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    12:16 AM Shriram Jayakumar (Legal Executive, Baker & McKenzie.Wong & Leow)

    A sensible approach to severance: Tillman v Egon Zehnder [2019] UKSC 32

        

    Introduction

    If the unreasonable portions of a restrictive covenant are severed from the reasonable portions, will employers be escaping the consequences of widely-drafted restrictive covenants that they were responsible for? Or will this allow their legitimate interests to be protected?

    For a long time, the law was concerned with the former outcome and the impact this would have on a defenceless employee. But as Tillman v Egon Zehnder [2019] UKSC 32 demonstrates, the law increasingly recognises that companies may have legitimate interests that are protected by the remainder of a restrictive covenant, especially when dealing with high-ranking employees.

    The UK Supreme Court endorsed a more sensible approach to severance which is consistent with case law. However, the precise formulation of the test it has adopted may need further refinement moving forward.

    Background

    The dispute concerned the interpretation of a non-compete clause in an employment contract between Egon Zehnder Ltd (“Egon Zehnder”) and Mary Caroline Tillman (“Tillman”). Egon Zehnder was a worldwide group which specialised in executive search and recruitment and Tillman, who had joined the group as a consultant, was the group's joint global head of financial services at the time of her resignation.

    Upon the end of her employment with Egon Zehnder, Tillman informed the group that she would soon be commencing work with a direct competitor. Egon Zehnder sought an interim injunction against Tillman to restrain her from doing so, on the basis of a non-compete clause in her employment contract.

    Arguments and findings at the lower courts

    The non-compete clause stated that, post-termination, an employee would not "directly or indirectly engage or be concerned or interested in any business carried on in competition with [Egon Zehnder]" for 6 months.

    Tillman contended that the term "interested in any business" extended to shareholdings in competitors and that such a prohibition amounted to unreasonable  restraint of trade.  

    Egon Zehnder argued that the non-compete clause did not extend to shareholdings. It pointed to another clause which restricted employees to limited shareholdings in competitors during their employment with Egon Zehnder and argued there would be a commercial anomaly if Tillman’s post-termination obligations were wider than her obligations during employment.

    At first instance, before the English High Court, Mann J found that the non-compete clause did not cover shareholdings but this was reversed on appeal by Longmore LJ.

    Arguments and findings at the UKSC

    Egon Zehnder raised the following arguments before the UK Supreme Court:

    1. The doctrine of restraint of trade is not engaged when considering post-employment shareholding restrictions (the "ROT doctrine issue");
    2. Alternatively, applying the principle of validity, the Court should prefer a construction of the non-compete clause which does not prohibit shareholdings (the "construction issue"); and
    3. In any event, the impugned part of the non-compete clause should be severed and removed from the remainder of the clause (the "severance issue").

    The Supreme Court's approach to all three issues will be examined in turn. In particular, its holding on the severance issue was the most significant and merits close scrutiny.

    The ROT Doctrine Issue

    Egon Zehnder had argued that not every post-employment restriction in an employment contract would restrain trade; for instance, prohibiting Tillman from playing mah-jong would not curb her freedom to work.

    The Supreme Court acknowledged that while there have been questions about the width of the ROT doctrine, prohibitions on shareholdings would fall under this doctrine. First, Tillman had acknowledged via another clause that the non-compete clause was fair and reasonable. This represented a clear acknowledgment that the non-compete clause fell within the ROT doctrine. Secondly, it was unsurprising that Egon Zehnder would aspire to prohibit an employee from holdings shares in a competitor because shareholders can influence the operations of a competitor even with a minority stake; with a majority stake, they could go so far as to control the competitor's operations. Accordingly, a prohibition on shareholding would seek to restrain the trade that the former employee could engage in and would thus fall under the ROT doctrine.

    The Construction Issue

    It was Egon Zehnder's case before the English Court of Appeal (and presumably before the UK Supreme Court given they had considered this argument) that the Court should favour a construction which validated a clause because parties to a contract would have intended it to be valid i.e. the validity principle. It followed that the term "interested" in the non-compete clause should not be construed as covering shareholdings.

    The Supreme Court first examined the limits of the validity principle. It held that the principle applied but only where the construction which validated a clause was realistic.

    The Supreme Court then held that Egon Zehnder's construction of "interested" was not realistic for two reasons. First, Egon Zehnder could not define what the term covered but only what it did not cover i.e. shareholdings. Secondly, long-standing authority had affirmed that the word "interested" covered shareholdings.

    Thus, the principle of validity could not result in the term "interested" no longer covering shareholdings.

    The Severance Issue

    It was the final arrow in Egon Zehnder's quiver that hit the bullseye. Egon Zehnder argued that the words "or interested" should be severed and removed from the non-compete clause, thereby leaving the remainder of the clause enforceable. Tactically, this would not pose problems for Egon Zehnder since it had always maintained that Tillman was free to acquire shares in a competitor so long as she did not directly work for them.

    The UK Supreme Court laid out three requirements that needed to be fulfilled before the unenforceable portion of a restrictive covenant would be severed from the remainder of the covenant:

    1. There was no need to add to or modify the wording of the remainder;
    2. The remainder continued to be supported by adequate consideration (a requirement which could usually be ignored); and
    3. The removal of the unenforceable provision would not generate any major change in the overall effect of all the post-employment restraints in the contract.

    Applying this test, the Supreme Court found that the words "or interested" could be severed because, first, they were capable of being removed without the need to add to or modify the wording of the remainder and, secondly, the removal would not generate any major change in the overall effect of the restraints.

    The remainder of the non-compete clause thus read "directly or indirectly engage or be concerned in any business carried on in competition with [Egon Zehnder]". To this end, the Supreme Court also disagreed with the Court of Appeal that to be a shareholder is to be indirectly "concerned in" the business. The Supreme Court held that value had to be attributed to each word of an agreement and so, if the word "concerned" covered passive interests like shareholdings, then no value would be left to be attributed to the word "interested".

    Resolving (and refining) the test for severance

    Prior to this decision, there was uncertainty as to the applicable test for severance of unenforceable portions of a restrictive covenant from enforceable portions. There were essentially two approaches endorsed by the English Court of Appeal at different points in time: the conservative approach in Attwood v Lamont [1920] 2 KB 146 ("Attwood test") and the more flexible approach in Beckett Investment Management Group Ltd v Hall [2007] EWCA Civ 613 ("Beckett test"). The UK Supreme Court in Egon Zehnder essentially adopted a modified version of the Beckett test ("Modified Beckett test").

    Attwood test

    The Attwood test entails two requirements:

    1. The restrictive covenant under examination is not really a single covenant but is in effect, a combination of several distinct covenants; and
    2. The part proposed to be removed is no more than trivial or technical.

    The UK Supreme Court's departure from the Attwood test is to be welcomed.

    The first requirement of the Attwood test causes much uncertainty. In theory, "[t]he question of what is a single covenant […] is in each case one as to the proper construction of that particular covenant" (H G Beale QC, Chitty on Contracts (Sweet & Maxwell, 33rd ed, 2018) at para 16-240). But in practice, there is no bright line as to whether a covenant is one covenant or, in effect, multiple covenants. For example, a list of prohibited trades was construed as a single covenant in Atwood but as multiple covenants in Putsman v Taylor [1927] 1 KB 637 and Scorer v Seymour Jones [1966] 1 WLR 1419.

    The second requirement has little to no support in authority, as observed in T Lucas & Co Ltd v Mitchell [1974] 1 Ch 129 at 136. But further, the requirement of triviality or technicality is emblematic of an attempt to negate the application of the severance doctrine altogether.

    Problems with application aside, the strictness of the Attwood test may not always be justifiable. The Attwood test was meant to prevent employers from intentionally drafting wide restrictive covenants and then, fearing they had gone too far, asking the courts to carve out of the void covenant the maximum of what the employer might have validly required.

    While courts should still adopt a cautious approach to severance, the above concern may be less prescient when dealing with high-ranking employees who are not only able to negotiate with their employers on a near-equal footing but can also do particular damage to the legitimate interests of their employers following termination of their employment. Tillman was one such high-ranking employee given that she was Egon Zehnder's joint global head of financial services at the time of her resignation.

    Beckett test

    The Beckett test reflects a better balance between the freedom of contract on one hand and the reasonable protection of an employer's legitimate interests on the other.

    To satisfy the Beckett test, three requirements must be met:

    1. There is no need to add to or modify the wording of the remainder of the covenant;  
    2. The remainder continues to be supported by adequate consideration; and
    3. The removal does not so change the character of the contract that it becomes not the sort of contract that the parties entered into at all.

    The main advantage the Beckett test has to offer is that it still preserves the cautious approach to severance through its third requirement. However, the artificial difference between single and multiple covenants as articulated in Attwood had now been eschewed. The Beckett test has also received the endorsement of the Supreme Court of Canada (Shafron v KRG Insurance Brokers (Western) Inc [2009] 1 RCS 157) and the High Court of Singapore (Lek Gwee Noi v Humming Flowers & Gifts Pte Ltd [2014] 3 SLR 27 at [155]).

    Modified Beckett test

    The UK Supreme Court clarified and modified the Beckett test. The first requirement of the Beckett test remained intact.

    As for the second requirement, the Supreme Court said that it could usually be ignored because in the typical case, it is the employer who seeks to enforce the covenant and for this reason, it would never be suggested that the consideration passing to the employee under the contract be reduced.

    The third requirement was modified to read "whether removal of the provision would not generate any major change in the overall effect of all the post-employment restraints in the contract" in order to sharpen the focus on the legal effect of the restrictions.

    The Supreme Court's decision continues the march towards a more sensible approach to severance which does not display an almost-blanket preference for finding an entire restrictive covenant unenforceable. However, its modifications to the Beckett test may have created practical difficulties in the application of the test.

    On the second requirement, it may be prudent to not ignore the need to prove that the remainder of a restrictive covenant is supported by adequate consideration. This allows the courts to determine if "[t]he offending provisions […] are not supported by separate consideration but are inextricably interwoven with the other promises in the agreement" (Kuenigl v Donnersmarck [1955] 1 QB 515 at 538).

    On the third requirement, it remains to be seen how this modification will work in practice. The Supreme Court simply noted that the deletion of the words "or interested" would not generate major change in the overall effect of the post-employment restraints in Tillman's contract without explaining why or giving guidance as to when such a major change would result. Without further clarification, this modified requirement could be doubted on the basis that the deletion of a widely-drafted restriction would always result in a major change to the effects of a contract's post-employment restraints.

    The requirement as originally formulated in the Beckett test i.e. whether there is a change in the character of the contract that it becomes not the sort of contract that the parties entered into at all, is capable of yielding more certainty than the Supreme Court's formulation. The inquiry is focused on whether "the main purpose of the contract is to impose the restraint"; if so, "the invalidity of that restraint can lead to the nullity of the whole contract" (Edwin Peel, Treitel on the Law of Contract (Sweet & Maxwell, 14th ed, 2015) at para 11.165). Under this inquiry, the end result of Attwood could still be attained under the Beckett test. In Attwood, the restrictive covenant prohibited employees from being concerned in "the trade or business of a tailor, dressmaker, general draper, milliner, hatter […]". Since the employee in Attwood was from the tailoring department, all the prohibited professions except for tailoring were deemed unreasonable. However, the Court of Appeal did not sever the other professions from the reference to tailoring. It found that the original covenant was "part of a scheme by which every head of a department was to be restrained from competition with the [claimants], even in the business of departments with which he had no connection". Thus, without getting into the semantic quagmire of separate or single covenants or trivial or insignificant parts of a covenant, the result in Attwood could have still been arrived at by using the Beckett test.

    Should employment contracts be re-drafted?

    Prior to the release of the UK Supreme Court's judgment, there was concern that if the term "interested in" covered shareholdings, and was thereby unenforceable for being in restraint of trade, restrictive covenants in employment contracts across various sectors would have to be redrafted (see generally "Unintentionally wide non-compete clause: A warning from the Court of Appeal in Egon Zehnder Ltd v Tillman" Cloisters (12 October 2017) and Michael McCartney, "Non-compete clauses should give business pause for thought" Personnel Today (28 January 2019)). This is because the term features prominently in restrictive covenants. The Supreme Court itself noted that it has been included in non-compete clauses in standard precedents throughout the last century.

    Employers may be relieved that while the Supreme Court held that the term covered shareholdings, it could be severed from the remainder of the restrictive covenant.

    However, this does not mean that, moving forward, restrictive covenants need not be updated to remove any prohibition on being "interested" in a competing entity. Depending on the other provisions of the employment contract and the parties' intentions in drafting it, courts may find that the overall effect of the non-compete clause is to impose wide-ranging restrictions on the employee. In such scenarios, severance is unlikely to be ordered.

    * This blog entry may be cited as Shriram Jayakumar, “A sensible approach to severance”  (25 July 2019) (http://www.singaporelawblog.sg/blog/article/237)

    ** A PDF version of this entry may be downloaded here

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