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Singapore – Can Court Fix Faulty Restrictive Covenants?

29 September, 2014

Introduction

 

Restrictive covenants in employment contracts are difficult to enforce. In fact, covenants in restraint of trade are prima facie void unless they can be shown to protect a legitimate interest of the employer, and that such protection is reasonable in the interests of the parties and of the public.

 

However, even where a restrictive covenant has failed the test of of validity, it may not necessarily spell the end of the road. The UK Court of Appeal has held that it has the power to salvage the restrictive covenant by – in the appropriate circumstances – interpreting or amending its terms so as to grant it functionality.

 

In this article, we look at two recent cases in which Courts were faced with the choice of whether to fix the ‘faulty’ restrictive covenants before them. We observe the intricacy of language required to build a restrictive covenant, and the importance of clear and effective drafting.

 

Interpretation & Re-Writing

 

To determine whether a restrictive covenant is enforceable, the Court must first construe what the covenant t means. In general, if faced with a contractual provision that can be seen to be ambiguous in meaning, with one interpretation leading to an apparent absurdity and the other to a commercially sensible solution, the Court is likely to favour of the latter. Such an approach can, however, only be adopted in a case in which the language of the provision is truly ambiguous and admits of clear alternatives as to the sense the parties intended to achieve.

 

The recent UK Court of Appeal case of Prophet plc v Huggett [2014] EWCA Civ C 1013 tested the boundaries of the Court’s power to interpret an ambiguous restrictive covenant in a commercially sensible manner. Here, the employer was a software developer and supplier, while the employee was a sales manager. The restrictive covenant prohibited the employee from engaging in competing business for 12 months after the termination of his employment. However, the restriction was limited to “any products, in, or on, which he/she was involved whilst employed hereunder”.

 

The UK High Court found that, that on a literal interpretation, the restrictive covenant gave the employer no protection. The employee was only involved in certain products under his engagement with the employer, and no other company dealt with these products, effectively meaning that that there was no restriction on the employee. However, the High Court held that the true intention of the parties would be served by adding the words “or similar thereto” to the covenant.

 

On appeal, the UK Court of Appeal overturned the decision of the High Court. While an ambiguous provision should be interpreted to give it commercial sense where possible, the covenant in this case was not ambiguous. The literal meaning resulted in a “toothless” prohibition, but what probably did go wrong was that the draftsman did not think through to what extent his chosen restriction would be likely to achieve any any practical benefit to the employer.

 

This decision demonstrates the narrow boundaries of interpretation as a remedial tool for restrictive covenants, and that the Court will not go out of its way to re-write an ineffective prohibition.

 

Severance

 

The doctrine of severance allows the Court excise an objectionable part of a clause or contract so as to save the rest of the clause clause or contract from being void. The test for severance is that:

 

(i) The unenforceable portion must be capable of being removed with the remainder continuing to make grammatical sense;

 

(ii) The remaining contractual terms must continue to be supported by adequate consideration; and 

 

(iii) The severance must not change the fundamental character of the contract between the parties.

 

In Lek Gwee wee Noi v Humming Flowers & Gifts Pte Ltd [2014] 3 SLR 27, the Singapore High Court was faced with restrictive covenants which had been found to be unreasonable in light of geographical restriction, activity restriction, and temporal scope. It then had to decide whether the covenants could be remedied by severing the offending portions. 

 

On the facts, the Court was unable to sever the objectionable parts of the restrictive covenants without, inter alia, fundamentally changing the character of the agreement so as to effectively rewrite it. Notably, the Court also suggested disapproval of the doctrine of notional severance, which per permits a thorough and explicit rewriting of the contract, choosing instead to support the comparatively stricter traditional doctrine of severance.

This decision demonstrates the stringent criteria to be fulfilled before the doctrine of severance can be applied to remedy a restrictive covenant.

 

Concluding Words 

 

As can be seen, the Court will not easily step in to fix a “toothless” restrictive covenant. Employers are often in a far more advantageous position to dictate the terms of an employment agreement, and where they have chosen a restrictive covenant which has been inexpertly phrased so to render it invalid, they are likely to find it a difficult task to obtain the Court’s help in correcting its terms.

 

Employers should thus ensure that they are properly advised in the drafting of restrictive covenants so as to ensure that the interests they seek to protect are effectively guarded. 

 

Rajah & Tann

 

For further information, please contact:

 

Mohammed Reza, Partner, Rajah & Tann

mohammed.reza@rajahtann.com 

 

Wilma Cheng, Partner, Rajah & Tann

wilma.cheng@rajahtann.com

 

Ryan Loh, Partner, Rajah & Tann

ryan.loh@rajahtann.com

 

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