Cayman Islands: Sharpening The Blue Pencil: The UK Supreme Court Clarifies The Law Of Restrictive Covenants

Last Updated: 19 July 2019
Article by Nick Dunne

Most Read Contributor in Cayman Islands, August 2019

Restrictive covenants are a common, even standard, feature of employment contracts for senior members of staff, but the manner in which they are treated by the courts is perhaps less commonly understood. The recent UK Supreme Court case of Tillman v Egon Zehnder Ltd1 is the first time that the issue has been considered at final appellate level, and has resulted in some important guidance in this regard. Although arising in the context of an English case, this is likely to be equally applicable in both the Cayman Islands and the offshore world more generally.

Factual Background

Mary-Caroline Tillman was a successful and senior manager, who had previously been employed by JP Morgan as European Managing Director. In early 2004 she took up employment as a consultant with Egon Zehnder Ltd, an executive recruitment firm, on a substantial annual salary, and was subsequently promoted to become joint global head of the company's financial services practice. Her contract of employment, as might be expected, contained a number of restrictive covenants, including a term that she would not for a period of twelve months "directly or indirectly engage or be concerned or interested in any business carried on in competition with any of the businesses of [Egon Zehnder]..."

On 30 January 2017 Ms Tillman ceased employment with the company and shortly afterwards announced that she intended to start work on 1 May 2017 with a competitor, claiming that her non-competition covenant was an unreasonable restraint of trade and therefore void. Egon Zehnder sought an injunction prohibiting her from doing so.

Her defence came down to the single argument that because the prohibition on being "interested" in any competing business meant that she could not even acquire a minority shareholding in such a business2, that exceeded the company's need to protect its legitimate interests, was unreasonable, and thus rendered the entire non-competition clause void. In contrast, the Company responded that the clause did not have that effect, and that even if it did, the words "or interested" could be removed from the clause, leaving the remainder intact and enforceable.

At first instance, the High Court (Mann J) found in favour of the company on the basis that the clause did not prohibit minority shareholdings. However, the Court of Appeal reversed that decision, rejecting that interpretation of the clause and going on to refuse to sever the offending words from the remainder of the clause, with the result that the entire covenant failed.

Legal Development

And so the matter came to the Supreme Court, albeit some eighteen months after the term of the covenants had in fact expired. In giving the sole judgment, Lord Wilson comprehensively reviewed the development of the law in respect of restrictive covenants since the 1400s, in particular the evolution of the position from one in which all restraints of trade were void3 to one in which from the early 17th century there was an increasing recognition that employers may have legitimate interests the protection of which was sufficient to justify the imposition of limited restrictions on departing employees.

The result of that evolution is that the courts are now willing to enforce restrictive covenants, but only where they are within the boundaries of what is reasonably necessary for the protection of the employer's interests. Beyond that line, they will be void. However, an important nuance to that position is that where the line was crossed, the courts have been loathe to step in so as to redraft the provision in order to reflect what would have been reasonable:

"It would in my opinion be pessimi exempli ("a bad precedent") if, when an employer had exacted a covenant deliberately framed in unreasonably wide terms, the Courts were to come to his assistance and, by applying their ingenuity and knowledge of the law, carve out of this void covenant the maximum of what he might validly have required. It must be remembered that the real sanction at the back of these covenants is the terror and expense of litigation, in which the servant is usually at a great disadvantage in view of the longer purse of his master"4.

The underlying policy of this approach is clear and sound: if an employer can rely on the courts to simply reconstitute clauses to impose the maximum restriction reasonable, there is no reason not to (and indeed a positive incentive to) insist on unreasonably broad covenants on the basis that, at worst, they will be reduced, and at best the employee will not have the resources or inclination to challenge them so they will remain effective in full.

Consequently, the courts have been more willing to consider severance of clauses by removing offending language, as opposed to the wholesale substitution of clauses to reflect something which neither of the contracting parties had ever agreed to. Even when considering severance, significant reluctance prevailed, looking to whether removal would be possible without altering the nature of the contract, and in some cases whether the language that was sought to be removed was no more than "trivial or technical" in nature.

It is not unfair to say that there was a distinct lack of consistency between the various judges compelled to wrestle with these issues over the years as to precisely what test ought to be applied, an uncertainty which was also reflected in a divergence of views in other common law jurisdictions. However, many of those uncertainties have now been resolved, at least for the time being, following the reconsideration of the position in Tillman.

The Supreme Court's Analysis

Lord Wilson was careful to acknowledge the reality that although certain senior employees may be in a position to negotiate the terms of their contracts on nearly equal footing with their employers, that is not the case in the vast majority of cases, the norm being that most people are not only forced to contract either on the terms offered to them or not at all, but also are unlikely to be in a position to defend a claim that they are in breach of covenant. In those circumstances, although the court adopted a more liberal approach than that which had prevailed in some of the previous authorities, caution remained justified.

That caution was reflected in a refusal to accept any general power of amendment, but instead to endorse the "blue pencil" test5, that is to say the principle that although words can be deleted, they may not been added in. Whilst it was acknowledged that this test could sometimes be capricious in application, the extension of any power beyond it was said to be a matter for the legislature rather than the common law6. As such, the principle that an unenforceable provision will only be severed where it is capable of being removed without the need to add or modify the wording of what remains is now settled.

As to the effect of the severance on the nature of the contract, Lord Wilson accepted that this was an important consideration and it would be wrong to make a change the result of which would be to change the character of the contract into something which was not what the parties entered into at all. He expressed the criterion as being "whether removal of the provision would not generate any major change in the overall effect of all the post-employment restraints in the contract", and emphasised that it was for the employer to establish that removal would not do so.

On the facts of Ms Tillman's case, the court took the view that the Court of Appeal was correct to construe the covenant as prohibiting any shareholding, no matter how small, in a competitor, there being no other realistic construction, and that such a prohibition was unreasonable. However, the problematic words "or interested" could be removed from the clause without any need for addition to or modification of the words that remained. Nor would that removal generate any major change in the overall effect of the covenants. Accordingly, severance was possible and the remainder of the clause was still enforceable.

Conclusion

Tillman provides a welcome clarification of the proper approach to potentially unreasonable restrictive covenants, and should act as both a reassurance and a warning to employers. On the one hand, the affirmation of the power to apply the "blue pencil" test and excise an unreasonable element of a covenant without losing the remainder is a practical approach to the issue, and takes account of the genuine need for employers to be able to properly protect their interests.

However, the boundaries of that power are clearly defined, and it is apparent that employers cannot safely assume that the court will save them if they do attempt to impose unreasonable covenants. It is beyond doubt that the court may not redraft a provision, and the more broadly unreasonable the restriction, the less likely it is that the court will be able to remove the offending parts within the scope of its power to do so. There remains a real risk that attempting to impose too onerous a restriction will result in the covenant failing altogether.

Finally, Lord Wilson concluded by noting a potential "sting in the tail" for employers forced to resort to the court's blue pencil in order to render covenants enforceable. In inviting submissions on costs, he described the unreasonable parts of covenants as "legal litter" and noted the unfair burden that they placed on others to clear them up. Even where an employer is successful, it appears that they might have a further fight on their hands when it comes to the recovery of their costs.

This decision re-emphasises the importance of a careful approach to restrictive covenants by employers, and a detailed consideration of the extent to which they are genuinely and reasonably necessary in order to protect their business. It is clear that the courts will have little sympathy for attempts to impose onerous and overly broad restrictions, the price of which may well be that an employer will be left wholly unprotected. In the world of restrictive covenants, it remains the case that less is very often more.

Footnotes

1. [2019] UKSC 32

2. She did not in fact have any such shareholding, nor did she intend to acquire one, but that was agreed by all of the courts considering the matter to be irrelevant.

3. In Dyer's case before the Court of Common Pleas in 1414, Justice Hull stated that "By God, if the [employer] was here, he would go to prison until he paid a fine to the King".

4. Lord Moulton in Mason v Provident Clothing and Supply Co Ltd [1913] AC 724

5. "...the courts will sever in a proper case where the severance can be performed by a blue pencil but not otherwise" – Bailhache J in Attwood v Lamont [1920] 2 KB 146

6. For example, in New Zealand, an express power to rewrite unreasonable covenants has been conferred by statute.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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