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High Court considers severance in non-compete clauses

Practical Law UK Legal Update Case Report 6-504-9611 (Approx. 5 pages)

High Court considers severance in non-compete clauses

by PLC Commercial
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The High Court considered whether to apply the blue pencil test of severance to restrictive covenants in a franchise agreement in Francotyp-Postalia Ltd v Whitehead and others [2011] EWHC 367. (Free access)
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The High Court has considered whether to sever non-compete clauses, in a decision that illustrates some of the pitfalls for those drafting restrictive covenants and severance clauses. In this case, the court held that it was not possible to sever the offending wording in one (unenforceable) restrictive covenant because it would have the effect of modifying other (enforceable) restrictive covenants. The decision shows the limitations of the blue-pencil test of severance, which works only by deletion, not allowing the smallest addition or substitution, and then only if the text deleted is so self-contained that removing it does not affect the rest of the wording or distort the parties' bargain. This case also raises the question to what extent a severance clause can extend this very limited protection. (Francotyp-Postalia Ltd v Whitehead and others [2011] EWHC 367)

Background

Restrictive covenants can help protect a business from unfair competition from business partners and employees who have had privileged access to its customers and information. They may cover:
  • Non-solicitation of staff or customers.
  • Non-competition with the business.
Lawyers responsible for drafting these clauses know how important it is to keep them reasonable; an excessive clause will offend the policy against clauses in restraint of trade, making it unenforceable (see PLC Employment, Practice note, Restrictive covenants and garden leave). For this reason, the restrictions are normally limited in duration, geographical area and content.
Although the clause that goes too far in restraint of trade will be void, the surrounding contract may survive if the court can "blue-pencil" the offending clause. The blue pencil was the Victorian equivalent of today's red pen or strikeout font. If you can delete the offending clause without any rewriting, and without distorting the rest of the bargain, the contract survives. The same device can be used to preserve part of the clause. The process is also known as severance, because the offending words are severed, or cut out, from the contract or clause, leaving the rest of it enforceable. For more information see Severance: drafting note.
In considering the application of the blue-pencil test of severance, a court will apply a three-fold test (Beckett Investment Management Ltd & Ors v Glyn Hall & Ors [2007] EWCA Civ 613):
  • The unenforceable provision can be severed without the necessity of adding or modifying the wording of what remains.
  • The remaining terms continue to be supported by adequate consideration.
  • The severance of the unenforceable provisions does not distort the parties' bargain so much that it materially differs from the contract the parties entered into ("does not so change the character of the contract that it becomes not the sort of contract that the parties entered into at all").
However, when the court is asked to apply the blue-pencil test, it will not make a new contract for the parties, and it will not sever the unenforceable parts of a contract unless it accords with public policy to do so.
Contracts often contain a severance clause, expressly encouraging the court to sever any offending part of the agreement and seeking to agree in advance that whatever is left should be enforceable. Even if they add nothing to the common law, these clauses may encourage a judge, in case of challenge, to enforce at least part of the restrictive terms. For an example, see Standard clause, Severance.

Facts

The claimant (the franchisor) manufactured, sold and maintained franking machines and postage scales. The defendants entered into two franchise agreements with the claimant. The agreements contained restrictive covenants which took effect on termination of the franchise, with restrictions (in separate sub-clauses) on soliciting clients and staff (non-solicitation clause), supplying competing goods (non-supply clause), and engaging in a competing business (non-compete clause).
In order to help defend these restrictions against challenge, and encourage a court to apply its blue pencil:
  • All the restrictions were limited in time to one year.
  • The non-solicitation clause, the non-supply clause and the non-compete clause were limited in territory to the "Restricted Area", which was defined as the original franchise territory plus other areas. The definition of Restricted Area was contained in the non-compete clause.
  • Each restriction was in a separate sub-clause.
  • The contract included a severance clause.
The severance clause repeated the common-law blue-pencil test, but provided that a court might make the minimum necessary changes to the period or geographical area needed to avoid complete unenforceability. The severance clause stated that if a restriction were void for any reason, "that restriction shall apply with such deletions or with such reduced period or area of application as may be necessary to make it valid and effective".
On termination, the claimant claimed damages for breach of these restrictions. The defendants denied any breach and argued that, in any case, the restrictions were too wide to be enforceable.
By the time the claim came to trial, the parties had agreed that:
  • The non-solicitation clause was valid throughout the Restricted Area.
  • The non-compete clause was unenforceable if it extended to the whole the Restricted Area.
  • If the definition of Restricted Area was "blue-pencilled" back to the original franchise territory, the non-compete clause would be enforceable.
The parties asked the High Court to rule on the question whether the definition of Restricted Area could be severed in part, reducing it to the original franchise territory and deleting the references to other areas, in the non-compete clause to make it enforceable.

Decision

The court refused to sever the definition of Restricted Area to save the unenforceable non-compete clause.
Although it was possible to reduce the Restricted Area for the non-compete clause to the original franchise territory, just by deleting text, this change to the definition of Restricted Area would automatically reduce the area of other restrictions (non-solicitation clause and non-supply clause, in which the term was used) which were not in restraint of trade and needed no change to make them enforceable.
As such, the first limb of the test of severance (that is, that offending wording can be struck out only by deletion, without any amendments to remaining clauses) was not satisfied. It also would have meant, in effect, that the court was rewriting the contract for the parties, so falling foul of the well established principle that it could not do so.
The judge also suggested that severing the definition would have meant a radically different contract to that initially entered into (the third limb), but it was not necessary to rule on this as the first limb was not satisfied.
Arguably, the severance clause, unlike severance in common law, expressly allowed the judge to amend the contract by reducing the area of application for the non-compete clause, without any change to the definition of Restricted Area. However, it is not clear from the judgment whether anyone took this point. The judge dealt with the severance clause in just one sentence of his judgment. He said, "I considered [the severance clause] but it does not seem to me to do anything other than repeat the common law principles of the blue pencil test".

Comment

This decision shows that there is no substitute, when drafting restrictive covenants, for paying careful attention to the scope of each restriction in time, space, and content. What is a reasonable geographical area for one restriction may be unreasonable for another.
It also shows the value of breaking the area of a restriction down into its constituent parts. Under the blue-pencil test, a restriction affecting England, Wales and Northern Ireland is more likely to survive, at least in part, than a restriction affecting the United Kingdom.
For the same reason, using a defined term within restrictive covenants may reduce severability. If the Restricted Area had been stated separately, in full, in each sub-clause, the non-compete clause might have been blue-pencilled and survived in part. So, one way to encourage severance is to divide restrictive covenants into many self-contained sub-clauses, so that even if one sub-clause fails, you need not add or replace anything to preserve the meaning of the rest.
Finally, this judgment raises, but sadly does not discuss or answer, the interesting question whether the courts will enforce a severance clause that appears to allow identifiable additions as well as deletion. While there is no harm in including such a clause, it is not safe to rely on it as a substitute for drafting reasonable restrictions in the first place.

Case

Francotyp-Postalia Ltd v Whitehead and others [2011] EWHC 367 (Ch), Peter Smith J.
End of Document
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Resource ID 6-504-9611
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Published on 03-Mar-2011
Resource Type Legal update: case report
Jurisdictions
  • England
  • Wales
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