Friday 9 June 2017

Restrictive Covenants - how long and how wide?

This is one of the hardest questions to advise upon when drafting contracts of employment for employer clients (or advising employee clients whether their covenants are enforceable).  It depends what is "reasonable" and cases are of limited use, as each turns on its own facts.  In other words, you have to second guess what a judge might think.

Here's an example:

"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;"

So, a non-compete clause for 6 months and apparently with no territorial limitation.  This is taken from the recent case of Egon Zehnder Ltd v Tillman [2017] EWHC 1278 (Ch) and was for a fairly high-powered executive headhunter in the financial services sector (a former European managing director and COO of JP Morgan before taking a career break).  The reasonableness of restrictive covenants has to be assessed at the date the contract was entered into (rather than when the employee leaves), and here she had started at the most junior "consultant" level (albeit on a guaranteed minimum of £220k p.a.) but eventually left at the most senior "partner" level.  The Group operated worldwide.

On first sight one might think 6 months is fine but no territorial limitation must be unreasonable.  But that's not quite how Mr Justice Mann approached it in the High Court, which shows how difficult these cases can be to advise upon.

The defendant did indeed try to argue the covenant was unenforceable due to its global reach, but didn't get very far.  The judge construed the restriction as only applying to businesses which competed with the businesses of Group Companies with which the employee had been materially concerned (and she had been concerned with some in other countries).  Thus there was "an in-built restriction on the global reach to the clause, deriving from the need for Mrs Tillman to have been involved locally."  This was therefore limited to what was reasonable to protect the Group's business.  Worth bearing in mind when drafting non-compete clauses for clients who say their business is global so they don't want a territorial restriction.  In reality they are unlikely to be operating in every part of the world, and involving the employee in those operations, so this formulation is a neat way of dealing with this.

The defendant also sought to argue that the clause prevented her from holding any shares in a competitor as an investment, and so went beyond what was reasonable to protect the employer's interests.  However there was another clause that expressly allowed shareholdings of up to 5% as an investment whilst still employed, so the Court held that the non-compete clause couldn't have been intended to have that effect after employment.  This shows the current approach of construing the wording to find the presumed intention of the parties, rather than construing any ambiguity against the party seeking to rely on the restrictive covenant.  It is also a reminder it's best to include an express exception for investments of this sort.

On the reasonableness of the 6 months, the discussion centered on how senior this employee really was.  The conclusion was that although she started at the junior consultant grade, she was clearly a high flyer whom the parties expected to move up the ranks (as proved to be the case).  So although her contract had never been updated, she was sufficiently senior that the covenant was enforceable against her. "Six months seems to me to be a reasonable period," said the Judge, "principally to allow the substitution of new relationships with the client and for the fading of confidentiality."  The implication here is that it could be tricky to argue for more than 6 months, even in fairly senior roles - though as ever it all depends on the facts of the particular case.






Wednesday 5 April 2017

Textualism and Contextualism

Working out what an ambiguously drafted clause in a contract means (or what a court is most likely to decide it means) is one of the trickier tasks for us lawyers.  The case law provides guidelines on the principles of contractual interpretation, but they do sometimes seem to conflict.

In Rainy Sky SA v Kookmin Bank in 2011 the Supreme Court took the contextualist approach, looking at the factual context and preferring the interpretation most consistent with business common sense. In Arnold v Britton in 2015 (which I blogged about here) the Supreme Court took the textualist approach, preferring the literal interpretation of the words used even if they gave an unjust result to one party.  So have the courts now "rowed back" from contextualism towards textualism?

Not according to the Supreme Court in the latest case on the principles of contractual interpretation, Wood v Capita Insurance Services Ltd.  According to Lord Hodge, "Textualism and contextualism are not conflicting paradigms in a battle for exclusive occupation of the field of contractual interpretation. Rather, the lawyer and the judge, when interpreting any contract, can use them as tools to ascertain the objective meaning of the language which the parties have chosen to express their agreement."

Which tool you use depends on the contract.  Sophisticated contracts which have been professionally drafted are more likely to be interpreted textually.  But the court recognised that "negotiators of complex formal contracts may often not achieve a logical and coherent text because of, for example, the conflicting aims of the parties, failures of communication, differing drafting practices, or deadlines which require the parties to compromise in order to reach agreement".  (This all sounds familiar from my experience of negotiating deals.)  More informal contracts which have been drafted without professional assistance are more likely to be interpreted contextually (perhaps because they may not make sense if taken out of the context and read literally).

Having made all that clear, the Supreme Court in Wood proceeded to uphold the Court of Appeal's literal interpretation of the contract (overruling the first instance judge's more contextual interpretation), but explained that this also made sense in the context.  The clause in question was an indemnity in a share purchase agreement by which Capita acquired a motor insurance broker specialising in classic cars.  It read (my highlighting):

“The Sellers undertake to pay to the Buyer an amount equal to the amount which would be required to indemnify the Buyer and each member of the Buyer’s Group against all actions, proceedings, losses, claims, damages, costs, charges, expenses and liabilities suffered or incurred, and all fines, compensation or remedial action or payments imposed on or required to be made by the Company following and arising out of claims or complaints registered with the FSA, the Financial Services Ombudsman or any other Authority against the Company, the Sellers or any Relevant Person and which relate to the period prior to the Completion Date pertaining to any mis-selling or suspected mis-selling of any insurance or insurance related product or service.”

Capita claimed £2.4m under the indemnity re the cost of a remediation scheme required by the FSA (now the FCA) to compensate customers for mis-selling, but the problem was that it had not followed and arose out of complaints by customers but from self-reporting by the company in accordance with regulatory requirements.  On textual analysis of this "opaque" provision the Supreme Court held that it did not cover losses which followed or arose otherwise than out of complaints.  Also looking at the context, it noted that there were wider warranties which did cover the loss (but were subject to a 2 year time limit which Capita had, for some reason, missed) and "It is not contrary to business common sense for the parties to agree wide-ranging warranties, which are subject to a time limit, and in addition to agree a further indemnity, which is not subject to any such limit but is triggered only in limited circumstances."

This last comment is very true, but in my experience indemnities usually focus on particular potential liabilities against which the buyer requires specific protection, and are not (or should not be) dependent on whether the liability arises in a particular way.  This looks more like a case of poor drafting to me.  But, as the court pointed out, it is not their function to improve a bad bargain.

All in all this is a helpful case in explaining how to go about interpreting contracts and what are the tools for the job, and it is good to see the Supreme Court showing such understanding of the realities of negotiating and drafting share purchase agreements.

I'm thinking of having a bumper sticker made for my BMW: "No tools of textual or contextual exegesis are left in this vehicle overnight".