18 March 2020

The Supreme court sharpens the “Blue Pencil Test” for restrictive covenants

Tillman v Egon Zehnder Ltd [2019] UKSC 32

In July 2019, the UK Supreme Court considered the enforceability of a restrictive covenant (in this case, a non-compete clause) in an employment contract.  Restrictive covenants are binding conditions typically contained in employment contracts which aim to protect the employer’s business from acts of the employee. As the Hong Kong Courts recently adopted the Beckett Test (see below for further information) this case is highly likely to also be adopted by the Hong Kong Courts in the future.

However, whilst they can be considered an unlawful restraint of trade, when they reasonably protect against a legitimate interest of the employer, the Supreme Court reconfirmed they will be enforced. 

The Supreme Court also considered the application of the so-called “blue pencil test”, a judicial standard dating back to 1894 for deciding whether to invalidate the whole covenant (in this case) or just the offending words - leaving the remaining words in the covenant intact. 

Employers should note the following, as underlined by the Supreme Court in its judgment of this case:

  1. restrictive covenants must be well-thought through and drafted clearly, unambiguously and reasonably.  This is so that any disputed wording can be carved out without causing the entire covenant to be held as unenforceable, or, as is undoubtedly preferable, such covenants pass the blue pencil test and consequently avoid disputes and/or challenges in the first place;

  2. the reasonableness of a restrictive covenant is judged at the time it was entered into, not at the time the employer seeks to enforce it.  For example, a subsequent promotion will not turn an invalid covenant into a valid one; and 

  3. restrictive covenants should go no further than what is necessary to protect the employer’s legitimate business interests at the relevant time.  

The Supreme Court concluded that whilst this case had an employer-friendly outcome, “the courts must continue to adopt a cautious approach to the severance of post-employment restraints of trade”.

Facts

The covenant contained in the employment contract of Ms. Tillman (the “Employee”), who was a senior executive at Egon Zehnder Ltd (the “Company”) (the “Contract”), stated that for six months after termination of the Employee’s employment, unless agreed, the Employee was not to “directly or indirectly engage or be concerned or interested in any business carried on in competition with any of the businesses of the company.”  

The Employee’s employment with the Company ended in 2017 and within the restricted six months period, she attempted to start a new job with a competitor.  After receiving notification of this from the Employee, the Company applied to the High Court for an injunction.  

The High Court initially heard the case in May 2017 and upheld the covenant, but this was promptly quashed by the Court of Appeal in June 2017 on the grounds that the use of “or interested” was: 

  1. too broad (as it would have prevented the Employee from holding even a minority shareholding in the new company); 

  2. unreasonable; and 

  3. incapable of being severed (or removed) using the blue pencil test. 

Judgment

The Supreme Court was asked to consider the validity of the wording “or interested”. Whilst the Supreme Court agreed that the restriction was too broad, it disagreed with the Court of Appeal and upheld the original High Court injunction in favour of the Company, finding that the wording “or interested” was capable of being severed.  

The Supreme Court followed the application of the blue pencil test from Beckett Investment Management Group Ltd v Hall [2007] EWCA Civ 613, i.e. whether part of a clause could be removed without a need to modify the rest of it and without it effecting the ‘character’ of the contract. It found that the words “or interested in” prohibited the Employee from having any shareholding, whether small or large, in a competitor and so was drafted unreasonably widely, as well as the clause being an unavoidable restraint of trade, without any type of minority carve out.  

Utilising the same rationale, the Supreme Court found that “be concerned… in” was reasonable, as it was questionable if a mere shareholder was “concerned” in a company.  This meant that unless “or interested” could be severed, the entire covenant would be unenforceable.  

Applying the blue pencil test, the Supreme Court found that once “or interested” was severed from the remainder of the clause, without needing to modify the wording of the rest of the clause, the covenant had the effect of fairly restraining the Employee’s ability to enter employment with a competitor, albeit the Employee could hold a minor shareholding in the competitor for investment purposes. 

As a result of the severing of the offending term “or interested”, the remainder of the restrictive covenant was therefore enforceable.

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