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Restrictive Covenants: Can a Court use the “blue pencil”?

02 Aug 2019

The case of Tillman v Egon Zehnder Limited was heard by the Supreme Court on 21 and 22 January 2019. It was the first case about restrictive covenants that the Supreme Court has heard in over 100 years. The Court gave its judgment on 3 July 2019.

Such  covenants are generally unlawful because they restrain trade. Hundreds of years ago – as the Supreme Court notes in its judgement - they were entirely unlawful. That remains the position in some legal jurisdictions to this day. 

Over the centuries, the law on covenants has evolved. Today a covenant is unlawful unless it: (1) seeks to protect the employer’s legitimate business interest and (2) goes  no further than is reasonably necessary to protect that interest. If the covenant protects a legitimate business interest but is too wide in its application, the Court will not enforce it.

The Supreme Court gave judgment in Tillman on a simple but important issue : can a  covenant which would otherwise be unlawfully wide be amended by the Court itself using the so called “blue pencil” to render the clause enforceable? 

The Court had before it two conflicting approaches to the problem. 

The first approach holds that a Court is not to come to the assistance of employers by amending  and thus making lawful clauses which would otherwise be unlawful. 

The second and opposing approach holds that a Court could amend a clause and make it enforceable where a failure to do so would enable an employee to avoid his or her contractual obligations, by finding examples of where the covenant would be unreasonable, even if those examples were irrelevant to the employee’s actual situation. 

The facts of the Tillman case:

Tillman was hired by Egon Zehnder in 2004, at which point she signed a contract including a six month non compete restrictive covenant. She was a success and promoted on several occasions until she became Co-Global Head of the Financial Services Practice Group. She resigned from this position with effect from 30 January 2017 and notified Egon Zehnder that she would be working for a competitor from 1 May 2017. Egon Zehnder sought an injunction against Tillman to prevent her from joining the competitor, as the  relevant covenant in her contract of employment prevented her from being “directly or indirectly engaged or…concerned or interested in” a competing business until 30 July 2017.

Tillman conceded that, in joining a competitor, she would be in breach of the covenant but argued that the covenant was an unreasonable restraint of trade and therefore void, and raised a number of arguments to support her claim, but sadly, only one reached the Supreme Court. This was the argument that the words “interested in”  were too wide, as it could prevent Tillman from being a minority shareholder in a competing business for investment purposes. Tillman agreed that she was not proposing to become a shareholder in a competitor but to work for the competitor, but said this practical point was irrelevant. The mere fact that the clause prevented her from doing so rendered it unenforceable. 

Tillman’s argument was rejected by a High Court Judge who gave Egon Zehnder the injunction it sought to prevent her from joining its competitor. Her argument was, however, accepted by the Court of Appeal. Egon Zehnder argued before the Court of Appeal that the words “interested in” should be deleted from the clause using the “blue pencil rule” thus making it enforceable. The Court of Appeal refused to do this as it held that the meaning of the covenant was clear and should not be amended to render what was unenforceable, enforceable. 

The Supreme Court agreed with the Court of Appeal that the natural meaning of the words “interested in” included a shareholding, large or small. Therefore, unless the “blue pencil rule” could be used to strike out the words “interested in”, the clause would indeed be an unlawful restraint of trade because it was too wide and thus void.

Turning to whether it could use the “blue pencil”, the Supreme Court overruled the Court of Appeal and held that the “blue pencil” could be used where:

i.    The words could be removed from the restriction without the need to add to or modify the wording of what remains;

ii.    The remaining terms continue to be supported by adequate consideration; and

iii.    The removal of the unenforceable part of the clause does not change the character of the contract so that it becomes a different contract to the one the parties entered into. (In other words it would not make any major change to the overall effect of the post employment restrictions in the contract).

Applying these rules to the clause, the Supreme Court concluded that the words “interested in” could be removed and, as they could be, the clause was rendered enforceable. 

So, relief for Egon Zehnder. But the Supreme Court’s judgment has a sting in the tail. The Court indicated that, where an otherwise unlawful clause was “rescued” by the use of the blue pencil, the usual order for costs – that the winner’s costs are paid by the loser – may not apply.  

Conclusion

The Supreme Court’s judgment in Tillman is useful for lawyers and their clients as the “blue pencil” rule may assist in rendering unenforceable covenants enforceable. A wholesale revision of existing covenants is also, probably, unnecessary. 

Nonetheless, it remains vital to exercise caution and careful thought when drafting restrictive covenants to ensure that an employer’s legitimate business interest is identified and that the extent of the restriction applied to the employee is no greater than is reasonably necessary to protect that interest. 

To avoid litigation, it may also be sensible to include a “carve out” to ensure minority or passive shareholding interests are not included in the restriction. It remains the case that the “blue pencil” rule will not be used to assist employers who have simply drafted restrictions too widely and without proper care. Even when an employer is able to persuade a court to use the “blue pencil” it may not recover its costs against the employee because the clause has had to be “rescued” by the court. So careful drafting remains vital.

If you have any further enquiries in realtion to the above article or restrictive convenants in general. Please contact Stephen ten Hove, Partner in DMH Stallards Employment Team.

 

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