Supreme Court takes pro-employer stance on severing restrictive covenants

Overview

The Supreme Court has handed down a landmark judgment on the interpretation of post-termination restrictive covenants; the first judgment on this issue by the highest UK court for a century. The decision provides a broad overview of the legal principles governing this contentious topic and a number of helpful lessons for employers who may be seeking to draft or enforce post-termination restrictions against their employees.

In particular, its decision largely restores the orthodox position on severance, by confirming that courts are able to delete – or "sever" – unreasonable elements of restrictive covenants and enforce the remaining provisions provided that the employer can show that removing the offending wording would not generate any major change in the overall legal effect of the all the post-termination restraints in the relevant contract.

Background

The Respondent was employed by the Claimant in 2004, as a recruitment consultant in its financial services group. She made swift progress throughout the organisation and was eventually promoted to co-global head of its financial services practice in 2012. She remained subject to her original contract of employment throughout this period, which contained a non-compete clause with effect for 6 months post-termination. In particular, this restriction stated that she should not "… 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…".

When she left the firm to join a competitor, the Claimant sought an injunction to restrain her activities in line with the above covenant. The High Court initially granted the injunction (see our commentary here), before the Court of Appeal (see here) overturned its decision on the basis that the words "interested in" – without any relevant carve out for shareholdings – unjustifiably prevented a theoretical minor shareholding in a competitor. The Court determined that: (i) this restriction was impermissibly wide; and (ii) it could not sever the offending element from within the individual non-compete clause and enforce the remainder. The entire provision was therefore struck out as an unenforceable restraint of trade. The Claimant appealed to the Supreme Court.

Lessons from the Supreme Court

In a wide ranging judgment, the Supreme Court discussed, restated and clarified the principles applicable to the drafting, interpretation and enforcement of post-termination restrictions which have developed in case law over the last 100 years. By reversing the decision of the Court of Appeal, and restoring the injunction granted at the High Court decision, it has provided the following key takeaways:

• Basic principle: The basic position at common law remains that any restriction on an employee's ability to work following the termination of their employment is void on public policy grounds as an unlawful restraint of trade unless it: (i) seeks to protect a legitimate business interest; and (ii) goes no further than is reasonably necessary, assessed at the time at which the contract was entered into, to protect that interest. Recognised "legitimate business interests" include the need to protect confidential information, client connections and workforce stability, whilst "reasonabless" depends on the envisaged scope of the restriction; primarily in terms of its length, the definition of the business to be protected and – less commonly in a globalised world – its geographical scope.

• Interpreting "interested in": Notwithstanding the Claimant's argument that the phrase "interested in" should not be interpreted as prohibiting passive share ownership in competitors for investment purposes, the Supreme Court was satisfied that – on a natural construction and in accordance with long-standing authority – the wording would cover any shareholding regardless of its size. Any non-compete clause which contains this phrase, and does not contain an appropriate carve out for passive minor shareholding, is therefore void as an unlawful restraint of trade unless that element of the restraint can be severed by a judge (on which see below).

• Restricting shareholdings = restraining trade: The Claimant also asserted that a post-termination prohibition on the ability to hold shares should not engage the restraint of trade doctrine on the basis that it was not – in itself – seeking to inhibit competitive activity. The Court unambiguously rejected this argument. In its view, a restriction on shareholding formed part of the overarching restraint on the Respondent's ability to work and/or trade after her employment and could not be extracted from the non-competition covenant as seeking to serve a separate purpose.

• Can a court strike out parts of an individual covenant and enforce the rest? Unlike the Court of Appeal, the Supreme Court answered this question in the affirmative; holding that it could delete the offending words "interested in" and enforce the remainder of an otherwise valid non-competition covenant. In its opinion, its ability to sever was not limited to entire, separate provisions; any element of a clause can be severed provided that the employer is able to demonstrate that:

• the "blue pencil" test is satisfied, namely that the offending words can be deleted from the provision without needing to add to or modify the remainder in order for it to retain sense;
• the remaining terms continue to be supported by adequate consideration; and
• the removal of the provision would not generate any major change in the overall legal effect of all of the post-termination restraints in the contract.

The Supreme Court felt that all three tests were satisfied, that the phrase "interested in" could be severed and that the remaining covenant was enforceable as a valid restraint of the Respondent's trade.

• Who bears the costs? The general rule in English civil litigation is that the unsuccessful party pays the legal costs of the successful party. Here, however, the Supreme Court sounded a warning for employers who successfully enforce post-termination restrictions, but have to rely on the court's ability to sever provisions in order to achieve this result. It endorsed wording to the effect that the severed, and unenforceable, elements of post-termination restrictions amount to "legal litter" which the employer should bear at least some responsibility for "clearing up" by way of the ultimate costs order.

Implications for employers

There is little question that this decision represents a positive development for employers. Whilst the Supreme Court emphasised that great care is required in order to draft enforceable post-termination restraints, it has confirmed that judges may strike out unreasonable elements of a restraint and enforce the remainder where such deletion would not fundamentally change the overall legal effect of the restrictions. This is likely to lead to a reduction in employees resisting restraints due to the way they are "split up" or presented within a contract. Employers should be aware, however, that any recourse to judicial severance is likely to lead to adverse cost consequences even where they are successful in achieving their primary remedy.

Now that this long-running case has been settled, and Supreme Court authority has been issued, employers would be well advised to review employment contract and service agreement templates to ensure that any post-termination restrictions are suitably tailored to particular individuals and roles. Organisations should also review internal processes to ensure that restraints are reviewed and restated depending on individual role changes, at which point the "threat" posed by individuals and the permissible scope of a reasonable post-termination restraint may increase.

A full copy of the Supreme Court's judgment is available here.