Are non-compete restrictive covenants now, in fact, as useful as a chocolate tea pot?

Are non-compete restrictive covenants now, in fact, as useful as a chocolate tea pot?

Published: 3 October 2017

If a key or senior employee of your company jumps ship and wants to joins a competitor; that non-compete restrictive covenant in their Service Agreement or Employment Contract will prevent them from doing so, and protect your business, won’t it?

Hmmmmm.  Well, maybe not.

Court of Appeal curve ball

The Court of Appeal has thrown yet another curve-ball into the existing melee which is the seemingly unresolvable question; what makes employee restrictive covenants enforceable? 

The general position is that a restrictive covenant (in an employment contract) will be void for being in restraint of trade unless the employer can show it has a legitimate business interest to protect and the protection sought is no more than is reasonable and necessary in respect of that interest.  This is never more applicable than in respect of non-competition covenants, which are often considered the most invasive of post-termination obligations.

In an effort to draft non-compete covenants which are both all-encompassing and also enforceable, both lawyers and employers are oft tempted to include as many nouns as possible to cover off every variation on what a departing employee may not do post-exit.  Whilst in some cases, unlawful words or provisions can be "severed" from the rest of a restrictive covenant in order to create an enforceable restriction; unfortunately this is not always the case.

The recent case of Egon Zehnder Ltd (EZL) v MC Tillman [2017] EWCA Civ 1054 deals particularly with these issues and are a lesson in how not to draft a post-termination non-competition covenant, if the intention is to rely on it.

The facts are simple: Ms Tillman wished to go and work for a competitor of EZL but was subject to a non-compete restriction on her doing so, which was drafted as follows.

13.2 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: […]

13.2.3 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 the period of twelve months prior to that date and with which you were materially concerned during such period."

Ms Tillman argued that the non-compete clause was void for being in restraint of trade (i.e. wider than necessary for the protection of its legitimate business interests). She asserted, inter alia, that being "interested" in a competing business was too wide as it could prevent her from having a minor shareholding in that competitor for investment purposes.

The Court of Appeal agreed and held that the restriction was indeed too wide to be enforceable as it was not possible to say that a shareholder in a company was not “interested” in that company based on “conventional usage” and other case precedent.

It then went on to consider whether the unenforceable wording could be severed. However, it concluded that it could not because:

(a) the clause was still too wide even if the void wording was removed (since being a shareholder is also "being concerned in" a business, albeit indirectly), and

(b) it is a requirement of severance that it can only take place where there are distinct covenants.  

Clearly, Ms Tillman’s issue was not that she wanted to hold a shareholding in a competing business, but she wished to have her covenant declared unenforceable so she could go and work for a competitor. Her intentions however, were not relevant; in the circumstances. She was able to simply and cleverly exploit defective drafting to extricate herself from the problematic covenant.

What does the case mean for Employers?

The Tillman case highlights that even the inclusion of a seemingly innocent term or word in a non-compete clause (by over-zealousness or otherwise) has the potential ability to remove the protection of the entirety of that clause.

If there is a non-compete clause in your contracts of employment which could be said to, or indeed states that it covers shareholding, then there now has to be a serious risk that the entire clause could be deemed invalid  - leaving the way open for that employee to argue the invalidity and join a competitor. 

That said, it is now fairly standard to have a series of “carve-outs” which follow the restrictions to clarify what the exiting employee CAN do. One of these is often to exclude any prohibition on minor shareholdings held by the employee (usually up to 5%) as an investment in any company.  Apparently this is sufficient to “save” the provisions to which it applies, as it would also include a shareholding in a competitor - but this has yet to be tested in the Courts.

As an Employer, what should I do now?

Now more than ever, very careful drafting is needed to ensure any non-compete restriction is properly composed and, that if widely drafted, it also specifically “carves out” the holding of shares in a competitor.

The Fletcher Day Employment Law team have extensive experience of advising on restrictive covenants. Contact Andrea London at Andrea@FletcherDay.co.uk or 0207 632 1442 for help and advice in reviewing these critical contractual obligations.

The contents of this article are intended for general information purposes only and shall not be deemed to be, or constitute legal advice. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of this article.