Mark Shulman, Consultant Solicitor at Keystone Law

RESTRICTIVE COVENANTS
Two recent decisions in the High Court provide a helpful recap on the legal principles concerning reasonableness of covenants and also guidance on the regime for seeking enforcement through inspection and disclosure of documents.

Reasonableness
Where details of teachers and schools were in the public domain via social media sites on the internet, did a recruitment agency have any protectable connection with its customers? And were restrictive covenants enforceable where they contained restrictions on the acts which the ex-employee may take "as a shareholder" of a competing company?

Both of these issues were considered in the recent case of [East England Schools CIC v Palmer & Anor ]()[2013] EWHC 4138 (QB) which provides a very helpful reminder of various general principles applicable in restrictive covenant cases and the judgment is well worth reading in full.

Background
Ms Palmer (the first defendant) worked for a recruitment agency ("4myschools") which matched teachers to schools in Essex.  Her contract of employment contained covenants not to solicit or to deal for a period of 6 months after the ending of her employment with the candidate teachers or client schools with whom she had dealt in her last 12 months. Those covenants were expressed to extend to actions carried out by her, not merely on her own account, but also "as principal, partner, shareholder, director, employee, consultant or in any other capacity whatsoever".

Ms Palmer got a new job with another teacher recruitment agency in London (Sugarman Education, the second Defendant). Sugarman Education wished to develop its business in Essex and so assigned Ms Palmer to work on building their business with secondary schools in the same area that she had covered for 4myschools.

4myschools received information which led it to believe that Ms Palmer was breaking the terms of her restrictive covenants after she signed undertakings and it then decided to bring High Court proceedings against both Ms Palmer and Sugerman Education.

*Were the restrictive covenants enforceable?
*At a final trial (rather than at an interim stage) the court had to decide (amongst other things) whether the restrictive covenants were legally enforceable.

The first issue was whether 4myschools had a relevant proprietary interest which the covenants were designed to protect. Part of Ms Palmer's defence was that with the increasing use of the internet and social media, relevant information was in the public domain and so could not be considered confidential to any particular agency.

The evidence was that in the market in this sector, much of the relevant information about teachers and schools was publicly available and schools generally used whichever agency could get them the best candidate at the right price when they need them. Candidates would usually sign up with multiple agencies and took the best offers that come in from time to time. Therefore, there was little loyalty owed either by schools or teachers to any particular consultant or to any particular agency.

However, the Court decided that 4myschools did have a sufficient proprietary interest that it was entitled to seek to protect in the connections which Ms Palmer would be likely to make while employed by 4myschools because:

* Ms Palmer was the name and (to a lesser extent) the face which represented 4myschools to its Essex secondary school clients and candidates and so the building up of relationships with schools and teachers was an integral part of the role envisaged for her; * although schools would ultimately use whichever agency has the right applicant, they had a choice about which agency to register with and to contact first and among those otherwise equal agencies, the relationship between the consultant and the manager might sometimes be the deciding factor; * Ms Palmer would, when she left, have taken with her in her head at least some valuable information confidential to 4myschools. Although identities, addresses, phone numbers and qualifications may all have been publicly available, Ms Palmer would have acquired other valuable information about schools and candidates in the course of her employment that was not publicly available.

*Reasonableness
*Would merely having a shareholding with a competitor mean that the restrictions were wider than was reasonably necessary for the protection of the employer? The relevant part of the covenants included wording that:

"The Employee covenants with the Company that she will not ..[do any of the acts specified] directly or indirectly, either alone or with or on behalf of any person, firm, company or entity and whether on her own account or as principal, partner, shareholder, director, employee, consultant or in any other capacity whatsoever ..".

It was argued that this would mean that Ms Palmer would be in breach of the clause merely (for example) by acquiring a small minority shareholding in a company which dealt with the same schools or teachers as she had dealt with at 4myschools, even if she played no active part in the business of that company. Ms Palmer relied upon the very recent unreported decision of Tugendhat J in White Digital Media Ltd v Weaver [2013] EWHC 1681 (QB). In that case a similar restriction was held by Tugendhat J as being wider than was reasonably necessary for the protection of the employer's legitimate interests and therefore unenforceable because the restrictions were capable of being infringed merely by the ex-employee owning a minority shareholding in a competing company.

However, whilst the White Digital Media case was concerned, like the present case, with covenants against soliciting or dealing with the employer's clients (or enticing away the employer's staff), the observations of the Court of Appeal in the case of Scully (UK) Ltd v Lee [1998] IRLR 259 on which Tugendhat J had relied, were by contrast directed towards a rather different type of clause. Scully was concerned with terms restricting the ability of the employee to be "engaged or concerned" in a competing business, even as a small minority shareholder.

Some of the clauses in her contract required Ms Palmer not to "canvass or solicit business or custom from any Client or Prospective Client in relation to Services". To infringe that provision would require a positive act of canvassing or soliciting. It was not a stipulation that could be infringed by the mere ownership by her of a minority shareholding. But there were other clauses for example, that required Ms Palmer not to "be concerned with the supply to any Client or Prospective Client of Services or otherwise deal with any Client or Prospective Client in relation to Services"(emphasis added). Therefore, it seemed to the Court that it was possible for Ms Palmer to fall within a prohibition against "be[ing] concerned with" the supply of competing services simply by being a minority shareholder in a competing company. It followed that the latter type of clauses ought not to have been enforced by injunction (or by undertaking) according to their original terms.

Blue pencil test
But that was not the end of the matter. The Court still had to consider whether any of the relevant wording (i.e.the phrase 'be concerned with the supply to any Client or Prospective Client of Services or otherwise") could be blue-pencilled or severed, so as to leave each of the relevant offending sub-clauses as a valid prohibition against dealing.

The authorities on severance were considered by Cox J in TFS Derivatives Ltd v Morgan [2004] EWHC 3181 (QB). A contract which contains an unenforceable provision nevertheless remains effective after removal by severance of that provision if the following conditions are satisfied:

* the unenforceable provision is capable of being removed without the necessity of adding to or modifying the wording of what remains; * the remaining terms continue to be supported by adequate consideration; * the removal of the unenforceable provision does not so change the character of the contract that it becomes "not the sort of contract that the parties entered into at all"; and * the severance must be consistent with the public policy underlying the avoidance of the offending part.

The Court decided that all four tests were satisfied and that the offending phrases in Ms Palmer's contract could be removed as a whole from the sub-clauses, without any re-writing of any other part of the clause. The phrase to be removed had no effect on consideration, did not change the underlying character of the contract and its removal was consistent with the underlying public policy. Therefore the Court could properly sever or "blue pencil" the phrases in italics in the following clauses:

15.2.3 for six months following the Termination Date and in competition with the Company or any Group Company [be concerned with the supply to any Client or Prospective Client of Services or otherwise] deal with any Client or Prospective Client in relation to Services;

15.2.7 for six months following the Termination Date [be concerned with the supply to any Candidate or Prospective Candidate of Services or otherwise] deal with any Candidate or Prospective Candidate in relation to Services;

Accordingly, the remainder of each of those sub-clauses was enforceable against Ms Palmer as a valid prohibition against dealing.

Enforcement and evidence
What principles apply when seeking disclosure and examination of hard drive images arising from alleged breaches of restrictive covenants and use of confidential information? Such issues were recently considered in [CBS Butler Ltd v Brown & Ors ]()[2013] EWHC 3944 (QB).

Background
The Claimants were former employers of the defendants, both of whom had left to set up a rival employment agency. In proceedings to enforce restrictive covenants the Claimant gained an order at an interim hearing to take images of hard drives of any mobile device, any personal e-mail account, any external media (including hard drives) and any cloud storage (all insofar as under the defendants' possession or control), but not to search or otherwise use these images without the Court's permission (or agreement of the defendants).

Having executed the Order, the Claimant sought permission to search the images taken pursuant to the previous Search Order. In summary, the effect of the order sought was that the only input into the process of disclosure which was to be permitted to the defendants was the identification of words to be put on a Blacklist (i.e. words on a list for the purposes of identifying documents which contained material irrelevant to the claim, including entirely personal material and privileged items). A hit which includes a Keyword (i.e. keywords for the purpose of identifying documents relevant to the claim), but not a Blacklist, was to be disclosed automatically to the Claimant (as well as to the defendants). A hit which includes a Keyword and a Blacklist was to be produced to the defendants solicitors for them to determine whether it contained information which is irrelevant or privileged, and any relevant information was to be disclosed subject to redactions.

What could be inspected?
The Court started by pointing out the difference in the CPR between standard disclosure (CPR r.31.7), when a party is required to make a reasonable search for documents and Search Orders (or Anton Piller orders as they used to be known) which under Practice Direction 25A have quite different requirements, as they allow specified persons to "search for, inspect, photograph or photocopy, and deliver into the safekeeping of the Applicant's solicitors all the documents and articles which are listed" in the Search Order (emphasis added). The original Order in the present case provided that inspection would not be at the initial stage of the search itself, but at a subsequent stage, and then only if that is permitted by the Court.

Therefore, the first question that arose on the application was what test should be applied to the decision as to whether or not to permit inspection. The proposed order resembled a simple Order for Inspection in so far as any documents not excluded by the filter were required to be sent to the claimant without the defendants having an opportunity to intervene.

Although keyword searches are suggested at para 9(3) in Practice Direction 31B (Disclosure of electronic documents), that Practice Direction did not address the question whether, and if so in what circumstances, disclosure should be ordered by a procedure that deprived the defendants of the opportunity of considering whether or not they shall make any disclosure. Nor did it mention the proposed use of a Blacklist as a filter.

The Court's view was that an Order which would deprive the defendants of the opportunity of considering whether or not they should make any disclosure was an intrusive order, even if it is made on notice. It would be contrary to normal principles of justice and could only be done when there was a "paramount need to prevent a denial of justice" to the claimant. The need to avoid such a denial of justice may be shown:

* before the defendant has had an opportunity to comply with disclosure obligations. But it was not sufficient for a claimant to show no more than that the defendant has misused confidential information or otherwise broken his employment contract. What a claimant must show is "substantial reasons" for believing that a defendant is intending to conceal or destroy documents in breach of his obligations of disclosure under the CPR; or * after the defendant has failed to comply with his disclosure obligations, having been given the opportunity to do so.

Was the test satisfied?
So what had the claimant shown? In the present case the claimant had adduced evidence that one of the defendants had sent to his personal email address and/or to another defendant, information which the claimant considered confidential and which related to one of its key clients. There was also evidence (albeit disputed) of one defendant seeking to cover up the fact he had forwarded that e-mail. The claimant was therefore left in a position where it simply did not know what information has been unlawfully diverted from its use to that of the defendants. It was for that reason that an application had been made for interrogation of the computer images.

There was no dispute that the claimant was entitled to disclosure of the defendants' documents (after service of the Defence) in the course of the normal procedure for disclosure. What was at issue was whether the claimant was entitled to deprive the defendants of the opportunity of considering whether or not they should make any disclosure of any particular documents, for example by asserting privilege.

At the later stage when the application for inspection came to be considered, a Defence had been filed and also evidence in the form of witness statements. This material had not been available when the original Search Order was made. The defendants were saying that there were innocent explanations of the matters relied upon by the claimant and any wrongdoing was denied. Although the claimant invited the judge to find that these explanations and denials were incredible, the proceedings were at an interim stage and as was usual on interim applications, the court had to refrain from making any findings of fact on disputed evidence. It followed that the claimant had "not come near to surmounting the threshold that it has to surmount" if it was to persuade the court to make so intrusive an order as one for disclosure to be carried out without the intervention of the Defendants.

Further, the Court had reservations about the proposed procedure. The defendants submitted that it would be impossible to conceive a suitable blacklist that could exclude the sheer range of personal documents that might contain one of the keywords. As a result, under the order proposed, the claimant would be given a significant amount of the defendants' private information and disclose communications with people who were entirely unrelated to the proceedings, as well as documents and information in respect of which persons not parties to the proceedings had rights of confidentiality and/or privacy.

The court agreed that the form of procedure for disclosure (by Keywords and Blacklist) proposed by the claimant would involve disproportionate risks of the interference with the privacy rights not only of the defendants, but also of third parties. For this additional reason, the Court declined to make the inspection order requested.

Mark Shulman is a Consultant Solicitor with Keystone Law and an accredited workplace and employment mediator.