Legitimate business protection or unenforceable restraint of trade – the problem with post-termination restrictions

Michael McCartney comments on a recent Court of Appeal decision in Egon Zehnder v Tillman highlighting the challenge employers face when enforcing clauses designed to prevent competition from employees after they leave.

The Court of Appeal held that a non-compete restriction which purported to prevent Ms Tillman from having an “interest” in a competing business was too broad to be enforced. The restriction would have prevented her from holding any shares at all in a competitor, regardless of their value. This position was at odds with her contractual right during her employment to hold a limited number of shares up to a maximum of 5%. There was clearly no basis upon which Egon Zehnder could possibly justify a more stringent protection after employment than had existed during it.

The court was not willing to interpret the word “interest” so as to exclude a shareholding and would not countenance severing the word altogether, because this would give a wholly different meaning to the covenant from what the parties had intended. Accordingly, Ms Tillman was free to take up her competing role just eight days before her restriction was due to lapse on 30 July 2017.

Facts

Egon Zehnder (EZ) is a global executive recruitment company. Ms Tillman was a star employee who had been quickly promoted through the ranks from consultant to partner and finally to co-Global Head of Egon Zehnder’s Financial Services Practice Group. In January 2017 she resigned to join the New York office of Russell Reynolds Associates (RRA), a direct competitor of EZ.   EZ sought injunctive relief to prevent her from joining RRA until after her non-compete restriction had lapsed on 30 July 2017.

The precise wording of the covenant at issue was as follows:

“You shall not without the prior written consent of the Company directly or indirectly, either alone or jointly with or on behalf of any third party and whether as principal, manager, employee, contractor, consultant, agent or otherwise howsoever at any time 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 such period.”

High Court decision

At first instance His Honour Mann J granted the injunction sought. Two issues of interest arise from his decision:

• The judge followed the approach in Patsystems v Neilly [2012], assessing the reasonableness of the covenant by looking forward from the date it was first entered into.  At that time Ms Tillman was a consultant in EZ. (Indeed, she had never been asked to sign any revised post termination restrictions since the outset of her career at EZ.)  Nevertheless, Ms Tillman had always been considered as a possible future star.  The judge held that it was appropriate to take into account the exceptional nature of her involvement with EZ’s business strategy and her extensive exposure to clients in her role as a consultant, even though this went well beyond the norm for someone at this level.
• Secondly, the judge chose an interpretation that would validate rather than invalidate the clause.  He determined that the prohibition on holding an “interest” in a competing business did not actually refer to a shareholding at all.  He concluded that, when considered alongside the restrictions operating during employment which expressly permitted a limited shareholding, the non-compete restriction must have been intended to prohibit other forms of interest such as a partnership or an indirect involvement through a nominee.   By adopting this approach he concluded that the restriction was permissible.

Court of Appeal

Just a single point of law arose before the Court of Appeal.  Ms Tillman submitted that the High Court had erred in this latter aspect of its decision, namely it had gone too far in excluding from the ambit of the restriction any intention to catch a shareholding in a competing business. Her counsel argued that the natural and clear meaning of the word “interest” would include a shareholding.  The Court of Appeal agreed.

The fact that Ms Tillman intended to take up employment with a direct competitor and not a shareholding at all was irrelevant to the difficulty that EZ faced in justifying the protection.  Put simply, EZ had overreached.

Severance

Finally, the Court of Appeal considered whether or not it could strike through or “blue pencil” the offending wording and give effect to the remaining covenant.  It held that it could not since this would involve changing part of a covenant and severance could only ever be applied to sever an entire covenant rather than part of a single covenant.  The judge held that the court had no business creating a valid covenant in order to replace an impermissibly wide one which an employer had sought to impose.

Comment

• The starting position remains that all post-termination restrictions are automatically void on the grounds of public policy since they amount to a restraint of trade.  The court will only enforce them where the employer can demonstrate that they are needed to protect a legitimate business interest.
• The onus is on the employer to justify the protection (invariably by showing that the employee had access to highly confidential information which would, in the hands of a competitor, give them an unfair advantage in the market).  To assess reasonableness the court will consider the forward-looking expectation of the parties at the point the covenant was entered into. This is why it is important for employers to regularly evaluate and update restrictive covenants particularly when an employee is promoted.
• Interestingly the Court of Appeal is due to consider a similar covenant shortly in the case of Tradition v Gamberoni. This covenant also purports to exclude an “interest” in a competitor in circumstances where the employee would have been entitled to hold a limited shareholding during their employment.  It remains to be seen if the court will follow the approach in the EZ case.  In the meantime, we would encourage clients to check their own restrictions to establish whether similar issues exist which might prevent their enforcement.
• Whilst Ms Tillman only managed to secure an eight-day head start before her covenant was due to lapse in any event on 30 July, the issue is unlikely to rest there. In order to secure an injunction from the High Court, EZ would have needed to provide a cross-undertaking in damages. It is likely therefore that Ms Tillman will claim relief against EZ for the period she was unable to join her new employer in addition to seeking reimbursement of her legal costs. The implications for EZ are likely to be significant.

Michael McCartney, Partner, Fladgate LLP (mmccartney@fladgate.com)