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Paul Goulding QC, Blackstone Chambers
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Title: Breaking up is hard to do : some recent cases on employee competition
Industrial Law Society
25 April 2006
Blackstone Chambers, Blackstone House, Temple,
London, EC4Y9BW
Tel: +44(0)20-7583 1770 Fax: +44(0)20 -7822 7350
Email: clerks@blackstonechambers.com
www.blackstonechambers.com
1. The aim is to consider three recent cases on employee competition, to identify issues of particular importance which emerge, and to suggest areas for future development.
TFS Derivatives Ltd v Morgan [2005] IRLR 246 (Cox J)
2. This decision contains a clear exposition of the approach the court adopts to the enforcement of post-termination restrictive covenants following a period of garden leave. It is unusual, and particularly helpful, in that judgment was given following a trial (rather than an interim application). It raises a number of issues, some of which remain unresolved, related to speedy trials, construction, legitimate interests, and reasonableness.
Facts
3. The essential facts are these:
Morgan’s job: Equity derivatives broker
Notice period: 3 months
Resignation: 7 June 2004 to join rival, GFI.
Garden Leave: 22 June 2004 - 7 Sept 2004
Termination: 7 Sept 2004
4. The contract contained restrictive covenants for 6 months against
(a) competing (less any period on garden leave);
(b) inducing employees to leave;
(c) employing employees.
The covenants are set out in an Appendix to this paper.
Decision
5. There was a 3-stage process to be undertaken (paras 36-39):
(a) Construction. The court must decide what the covenant means when properly construed.
(b) Legitimate business interests. The court will consider whether the former employers have shown on the evidence that they have legitimate business interests requiring protection in relation to the employee’s employment.
(c) Reasonableness. The covenant must be shown to be no wider than is reasonably necessary for the protection of those interests.
6. Finally, the court will decide whether, as a matter of discretion, the injunctive relief sought should in all the circumstances be granted, having regard, amongst other things, to its reasonableness as at the time of trial.
7. The Judge held that:
(a) all three covenants were enforceable (subject to a small amount of blue-pencilling);
(b) an injunction should be granted to enforce the non-compete covenant;
(c) there was no threatened breach of the other two covenants so no injunction was necessary.
Issues
8. Four interesting issues emerge.
(i) Speedy trial
9. Generally, it is thought that the test on applications for interim relief favours employers, not only in terms of the outcome of the application but also with regard to the overall tactics of the litigation. Has the speediness with which trials can now be arranged (at least in QBD) put employees in a stronger position?
10. American Cyanamid applies to restrictive covenant cases. Lansing Linde v Kerr illustrates the greater difficulty for employers when court delays were longer. Lawrence David v Ashton swung the pendulum in the employer’s favour when court delays were reduced.
11. In TFS itself:
6/9 Ex parte order
7/9 Termination of employment
15/9 Return date and order for speedy trial
9/11 Speedy trial started
11/11 Speedy trial finished
15/11 Judgment handed down
22/12 Expiry of covenants
(ii) Construction
12. Office Angels illustrated the danger to employers which can result from introductory words to a covenant restricting the range of interests on which an employer can rely to justify the covenant. In TFS, the introductory words were used as an aid in construing the covenant in a manner favourable to the employer: paras 41, 46.
13. Where there is an ambiguity in the meaning of a restrictive covenant, there may be a tension between two competing principles of construction. On the one hand, the contra proferentem rule favours the employee and points towards the unenforceability of the covenant (supported by the Court of Appeal in Arbuthnot v Rawlings [2003] EWCA Civ 518?). On the other hand, the courts may favour a meaning which upholds the contract (suggested by the Court of Appeal in Turner v Commonwealth & British Minerals Ltd [2000] IRLR 114). Cox J preferred the latter approach.
(iii) Legitimate business interests
14. The decision arguably represents a striking illustration, if not an extension, of the policing principle in the justification of the non-compete covenant.
15. Generally, a non-compete covenant may be justified by the need to protect confidential information based on the policing principle which underlies the approach of Lord Denning MR in Littlewoods v Harris [1977] 1 WLR 1472. The difficulty in policing an express confidentiality covenant may justify a non-compete restraint.
16. A non-compete covenant may not, however, ordinarily be justified by the need to protect client connection. This is because where a business interest can be adequately protected by a less onerous covenant, then a more onerous covenant designed for the same purpose is unreasonable (Office Angels). For example, client connection can ordinarily be protected by a covenant against dealing with clients. A non-compete covenant (which is more onerous than a non-dealing covenant) is, therefore, unreasonable if its purpose is the protection of clients.
17. An interesting feature of TFS is that the Judge considered that the difficulty in policing a non-solicitation or non-dealing clause may justify the more onerous non-compete covenant (para 84):
"greater protection is more likely to be secured from enforcement of a non-compete clause of the kind in clause 12.1(a) than from non-solicitation clauses which...are almost impossible to police in the circumstances of the employment with which we are concerned in this case."
18. How far might this approach extend? Is it limited to the particular circumstances of TFS or might it be of wider application?
(iv) Reasonableness and payment for covenants
19. It was argued for the employee that the non-compete was unreasonable on the ground that 6 months (paid) garden leave would provide the employer with equivalent protection yet would be less onerous for the employee.
20. Cox J was not persuaded that the point had been reached for garden leave clauses to negate the necessity for non-compete clauses in all cases. She offered 4 reasons:
(a) 6 months’ garden leave could be considered more onerous for the employee than 3 months’ garden leave plus 3 months’ non-compete.
(b) Garden leave was inappropriate where the employee was summarily dismissed or had summarily resigned.
(c) The imposition of 6 months’ garden leave might amount to a breach of the duty of trust and confidence.
(d) Payment was relevant only to the question of reasonableness between the parties. There was no inequality of bargaining power here.
21. Does the argument herald a trend towards the requirement for payment by an employer if a non-compete covenant is to be enforced? Practical and comparative experience points in this direction (cf Germany, Holland, France).
Item Software (UK) Ltd v Fassihi [2003] IRLR 769 (Nicholas Strauss QC); [2004] EWCA Civ 1244, [2005] ICR 450 (Mummery, Arden LJJ, Holman J)
22. This important decision establishes a director’s duty to disclose his own misconduct in appropriate circumstances, and points to further development of disclosure obligations for directors and employees.
Facts
23. The essential facts are these. Fassihi was Item’s sales and marketing director. During renegotiation of a distribution agreement with Isograph, a client, Fassihi proposed to the client that he would set up his own company and take over the contract.
24. In the end, Isograph terminated the contract with Item. When Item discovered Fassihi’s misconduct, he was summarily dismissed. Item sued Fassihi for breach of duty as a director and employee.
25. Item’s case against Fassihi was put in 3 ways:
(a) The diversion issue. In breach of duty, Fassihi sought to divert a business opportunity away from Item for his own benefit. The Judge found this had no impact on Item’s loss of the contract.
(b) The sabotage issue. In breach of duty, Fassihi encouraged Item to take a tough negotiating stance with Isograph. The Judge found this made no difference to the outcome of the negotiations.
(c) The disclosure issue. In breach of duty, Fassihi failed to disclose his own misconduct (consisting of seeking to divert the business to his own company) to Item. The Judge found that, had he made such disclosure, Item would have accepted Isograph’s proposals, not engaged in further brinkmanship, and secured the contract. The critical issue, therefore, was: did Fassihi owe Item a duty to disclose his own misconduct?
Decision
26. The Court of Appeal held that Fassihi was in breach of duty in failing to disclose his own misconduct.
27. The only reasoned judgment on the disclosure issue in the Court of Appeal was given by Arden LJ (with whom, on this point, Mummery LJ and Holman J agreed). The reasoning was based on principle, authority and policy.
28. Principle. Arden LJ’s conclusion was based (para 41)
"on the fundamental duty to which a director is subject, that is the duty to act in what he in good faith considers to be the best interests of his company."
This duty is general, dynamic and flexible.
29. Authority. In Bell v Lever Bros Ltd [1932] AC 161 (HL), the majority decided only that Bell owed no duty to disclose his misdeeds to his employer in the circumstances in which he found himself. The majority did not decide that (para 55):
(a) there could never be such a duty on the part of an employee; or
(b) a fiduciary would not owe any such duty.
30. Policy. A conclusion that a director owes no obligation to disclose his improper actions would be inefficient in economic terms (in terms of resources spent on investigation, uncertain outcome, and erroneous business decisions based on lack of essential information).
Issues
31. The decision gives rise to 4 issues of general importance.
(i) The position of an employee
32. It was unnecessary for the Court of Appeal to consider to what extent an employee has a duty to disclose his own misconduct (para 60). There are powerful arguments in favour of such a duty:
(a) Following Sybron v Rochem [1983] ICR 801, no logical distinction can be drawn between a rule that an employee should disclose his own wrongdoing and a rule that he should disclose the wrongdoing of his fellow employees even if that involves disclosing his own wrongdoing too (see Tesco v Pook [2004] IRLR 618).
(b) An employee also owes a duty of good faith and loyalty (cf Arden LJ’s reference to the "developing jurisprudence on the mutual duty of trust and confidence at para 60).
(c) An employee may owe fiduciary duties (see University of Nottingham v Fishel [2000] ICR 1462 (Elias J)).
(d) Nicholas Strauss QC at first instance in Fassihi found the defendant under a duty to disclose his own misconduct qua employee.
(ii) How far does the duty in relation to misconduct extend?
33. In RBG Resources Plc v Rastogi [2002] EWHC 2782, Laddie J held that it was arguable that, in addition to a "general obligation to whistleblow", an employee may be under a duty to investigate and take stops to prevent the misconduct of other employees.
(iii) What remedies are available for breach of the duty of disclosure?
34. Fassihi involved a claim for damages. An account of profits may also be sought. Might the court grant an injunction requiring an employee to disclose his own misconduct, or that of others of which he is aware (cf. Intelsec Systems Ltd v Grech-Cini [2000] 1 WLR 1190).
(iv) Policy and economic efficiency.
35. Note Arden LJ’s resort to economic efficiency as a policy argument supporting the application of an existing duty in a novel area, an approach apparent in other recent cases (see Mainstream below).
Mainstream Properties Ltd v Young [2005] EWCA Civ 861, [2005] IRLR 964 (Sedley, Arden LJJ, Aikens J)
36. This decision restricts the circumstances in which the new employer may be liable to the old employer for inducing breaches of employment contracts by employees. It also exposes a clash of economic ideologies relevant to policy arguments between appellate judges. The decision is being appealed to the House of Lords.
Facts
37. Mainstream is a property development company. Broad and Young were directors of Mainstream. They also owned their own companies which made property investments.
38. Two such investments were undertaken by Broad and Young’s companies with the help of finance provided by a third party, Mr de Winter.
39. Mainstream succeeded in its action against Broad and Young for loss of business opportunity. It also sued Mr de Winter on the grounds that he had induced a breach of Broad’s and Young’s contracts with Mainstream. His defence was that he accepted and relied on the assurance of Broad and Young that there was no conflict of interest for them in pursuing these investment opportunities since they had been rejected by Mainstream (although that was untrue).
Decision
40. Mainstream’s claim against Mr de Winter failed before the Judge and in the Court of Appeal. Whilst de Winter’s provision of funding constituted interference with the contracts between Mainstream and the two directors, he did not have the intention necessary commit the tort.
41. The intention required for the economic torts was analysed by the Court of Appeal in Douglas v Hello! Ltd [2005] 4 All ER 128. It identified several contenders for intention (para 159 of Douglas; para 39 of Mainstream):
(a) an intention to cause economic harm to the claimant as an end in itself;
(b) an intention to cause economic harm to the claimant because it is a necessary means of achieving some ulterior motive;
(c) knowledge that the course of conduct undertaken will have the inevitable consequence of causing the claimant economic harm;
(d) knowledge that the course of conduct will probably cause the claimant economic harm;
(e) knowledge that the course of conduct undertaken may cause the claimant economic harm coupled with reckless indifference as to whether it does or not.
42. The Court held that the essence of the economic torts is that the conduct is done with the object or purpose (but not necessarily the predominant object or purpose) of injuring the claimant; put another way, the conduct must be aimed or directed at the claimant.
43. Thus, only intention (a) or (b) will satisfy the requirement. Whilst intention (c) and (d) are insufficient, the fact that economic harm is inevitable or even probable my well be evidence to support a contention that test (b), or even (a), is satisfied.
Issues
44. Three issues call for comment.
(i) Distinguishing the different types of intention
45. Pending clarification by the House of Lords, it is likely to be difficult in many cases to distinguish between the types of intention, and decide whether the requisite intention is made out in any particular case.
(ii) Limiting liability of the new employer
46. It would appear that the circumstances in which the requisite intention on the part of the new employer is established are likely to be reduced in the future.
(iii) Policy and economic considerations
47. As in Fassihi, Arden found support for her conclusion in economic policy considerations. She was of the view that the imposition of greater liability on third parties for interference with contractual rights would carry with it the undesired effect, or at least the risk, of inhibiting competition and entrepreneurialism (para 76).
48. Sedley LJ struck a different note. He cautioned that economic theories are not neutral. In his view, legal theory needs to understand and declare what version of economics it is espousing before it reconfigures or adapts its doctrines to economic ends. Rather than favour competition or commerce, the common law’s business, in his view, was the maintenance of fair dealing within whatever framework legislation has created.
paulgoulding@blackstonechambers.com
Appendix: the TFS covenants
"12.1 In view of your access to sensitive information about the group and its business and since you are likely to acquire personal knowledge of and influence over its clients and in order to protect the goodwill of the group, you agree that during your employment and for the periods set out below after its termination (less in the case of para 12.1(a) any period during which you are not required to attend for work pursuant to para 11.3(b)), you will not (except with the prior written consent of the Board) directly or indirectly do or attempt to do any of the following:
(a) for 6 months undertake, carry on or be employed, engaged or interested in any capacity in either any business which is competitive with or similar to a relevant business within the territory, or any business an objective or anticipated result of which is to compete with a relevant business within the territory;
(b) for 6 months entice, induce or encourage an employee to leave or seek to leave his or her position with the company or any associated company for the purpose of being involved in or concerned with either the supply of relevant services or a business which competes with or is similar to a relevant business or which plans to compete with a relevant business, regardless of whether or not that employee acts in breach of his or her contract of employment with the company or any associated company by so doing; or
(c) for 6 months employ, engage or work with an employee for the purpose of the supply of relevant services or a business which competes or which plans to compete with or is similar to a relevant business.
12.2 For the purpose of this para 12:
(a) "relevant services" means goods or services identical or similar to or competitive with those which at the expiry of the relevant period the company or any associated company was supplying or negotiating or actively and directly seeking to supply to a client for the purpose of a relevant business;
(b) "relevant business" means the business of any business of the company or any associated company in which, pursuant to your duties, you were materially involved at any time during the relevant period;
(c) "territory" means England and any other country or state in which the company or any associated company is operating or planning t operate at the expiry of the relevant period...
(d) "employee" means a person who is employed by or who renders services to the company or any associated company in a relevant business in a managerial, broking, settlement, computer support, telecommunication or accounting capacity and who in either case was so employed or so rendered services during the period of six months ending on the last day on which you actively worked under this Agreement for the company or any associated company and who had dealings with you during that period;
(e) "relevant period"means the period of 12 months ending on the last day of your employment or the period of your employment if shorter than 12 months.