Restrictive Covenants Considered in Two Recent High Court Cases

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1 Restrictive Covenants Considered in Two Recent High Court Cases Recently, the Singapore High Court had to consider two cases where former employees that had set up competing businesses with their former employers challenged certain clauses in their former employment contracts as being in restraint of trade and, hence, void. In Mano Vikrant Singh v Cargill TSF Asia Pte Ltd [2011] SGHC 241, the clause in question stipulated that the employee would forfeit his right to receive deferred bonus payments if he competed with the former employer after leaving. In Smile Inc Dental Surgeons Pte Ltd v Lui Andrew Stewart [2011] SGHC 266, the employee had been subjected to restrictive covenants limiting post-termination competition. This Update looks at both decisions. Background: Restraint of Trade Interests capable of protection by restrictive covenants Restrictive covenants are common in a variety of situations such as employment contracts and sale of business agreements. They are usually used to protect trade connections or trade secrets. Courts will generally recognise these types of interests as being legitimately proprietary and, hence, capable of being protected by a restrictive covenant, provided the clauses are also reasonable. However, where restrictive covenants are used to prevent competition or otherwise prevent a person from legitimately exercising a trade or profession, they will be unenforceable. Test for reasonableness of restraint of trade clause Even where restrictive covenants are only used to protect legitimate proprietary interests, courts will examine them carefully to ensure that they do not go further than is necessary to do so. If they do, they will be regarded as being in restraint of trade and will be struck down. The leading case in Singapore as to the test to be applied is the Court of Appeal decision of Man Financial (S) Pte Ltd v Wong Bark Chuan David (2007). The Court of Appeal set out the following threefold test to be applied: Is there a legitimate proprietary interest to be protected? Is the restrictive covenant reasonable in reference to the interests of the parties? (UEN: T08LL0003B) is a limited liability law partnership registered in Singapore under the Limited Liability Partnerships Act (Chapter 163A).

2 Is the restrictive covenant reasonable in reference to the interests of the public? Facts of Mano Vikrant Singh v Cargill TSF Asia Pte Ltd Portion of bonus to be paid out in instalments In this case, the plaintiff worked at Cargill TSF Asia Pte Ltd (the defendant ) as a senior trader. The defendant provided its employees with an incentive award plan. The terms of the plan stipulated that payment of the incentive awards would be staggered: half would be paid immediately upon award, the other half would be paid out over a period of up to three years. These deferred portions ( Deferred Incentive Payments ) could be forfeited under certain circumstances. The provision on forfeiture ( Forfeiture Provision ) provided as follows: Deferred Incentives that have been awarded but not yet distributed will be forfeited if the Participant Separates from Service other than by reason of death or Disability, and continues a career within the financial or commodity trading industry outside of the Company within a period of two years from the date of such Separation from Service (referred to as the Two-Year Non-Compete Period ). Plaintiff left to set up own company After working for the defendant for about two years, the plaintiff resigned to work for a company that he had set up. The defendant alleged that this company was in the financial or commodity trading industry, and therefore asserted that it was entitled to rely on the Forfeiture Provision. It refused to make payment of outstanding Deferred Incentive Payments owed to the plaintiff. In total, the amount outstanding as Deferred Incentive Payments was US$1,741,894 excluding accrued interest. The plaintiff sued for the outstanding Deferred Incentive Payments, and argued that the Forfeiture Provision was void as being in substance a restraint of trade clause

3 Forfeiture Provisions Are Not in Restraint of Trade The Singapore High Court held that the Forfeiture Provision was not in restraint of trade. It first noted that the Court of Appeal in Man Financial (S) Pte Ltd v Wong Bark Chuan David (2007) had explained that the underlying policy behind the doctrine of restraint of trade was that every person should be at liberty to work for himself, and ought not (in principle) to deprive either himself or the state, of his labour, skill and talents. Cases in other jurisdictions have been divided The Court then considered prior cases from the United Kingdom, Australia, and the United States which had considered similar clauses providing for forfeiture of benefits where an employee leaves to join a competitor ( Forfeiture-for-Competition Clauses ). While some cases had held that such clauses were in substance restraint of trade clauses, others had held that such clauses were not in restraint of trade as they did not prohibit the employee from competing with the employer. Employee decides whether better to leave or stay The Court preferred the reasoning of the cases that had held that Forfeiture-for-Competition Clauses were not in restraint of trade. It agreed that the effect of such clauses was to operate as a financial disincentive for the employee to compete after he leaves the employer. If the employee decided to compete upon leaving the employment of the employer with full knowledge of the financial disincentive, then he would have made a calculated business decision that he would nonetheless be better off financially working for a competitor. Employee not prevented from leaving The Court noted, in particular, that as such clauses did not prohibit the employee from competing with the employer there was no compelling public policy that required the court to intervene. Furthermore, highly qualified employees like the plaintiff could negotiate with their new employers to compensate them for the loss of such deferred bonus as a condition for joining them. The Court made various other comments: The amount of the forfeiture was irrelevant to determining whether a Forfeiture-for-Competition Clause was in restraint of trade

4 It considered the effect of clauses that provide for forfeiture of benefits if the employee resigns (regardless of whether he goes on to work for a competitor). It commented that such clauses would not be in restraint of trade: They were in substance no different from Forfeiture-for-Competition Clauses and there could be no rational justification for treating them differently. Facts of Smile Inc Dental Surgeons Pte Ltd v Lui Andrew Stewart Defendant left to set up own dental practice The plaintiff in this case was a company that provided dental treatment. The defendant had been employed by it as an associate dentist. He resigned to set up his own practice, and many of the plaintiff s patients that had formerly been treated by the defendant left to become patients at the defendant s new practice. The plaintiff therefore sued for breach of various restrictive covenants. There were three restrictive covenants in this case. These were as follows: 23. Upon leaving The Practice, [the defendant] will not seek to damage or injure The Practice s reputation or to canvass, solicit or procure any of The Practice s patients for himself or any other persons. (the Non-Solicitation Clause ) 24. In the event that [the defendant] leaves (whether resignation or dismissal) The Practice, [the defendant] shall not practice within a 3 kilometre radius distance from [the plaintiff s] practices at Suntec City Mall and from Forum The Shopping Mall, and a 3 kilometre radius from any other new practices that have been set up before and during his cessation of work at The Practice. (the Geographical Limits Clause ) 25. In the event that [the defendant] leaves (whether resignation or dismissal) The Practice, existing and new corporate and non-corporate contracts, as well as existing and new patients, shall remain with The Practice. Patient data and records, office data and records and computer software programmes and data shall remain the property of The Practice, and such records, in full or in part, shall not be copied - 4 -

5 manually, electronically or otherwise be removed from the Practice. (the Non-Dealing Clause ) The Restrictive Covenants Were Too Wide Plaintiff was protecting trade connections The Court first considered whether the plaintiff had a legitimate proprietary interest to protect. In this case, the plaintiff was seeking to protect its trade connections, and the Court noted that in this regard it had to show that the defendant had personal knowledge of and influence over its customers. Other relevant factors would be the extent of that knowledge and influence, as well as whether the plaintiff had an institutional hold over its customers that would mitigate the defendant s personal influence. Defendant had influence over patients The Court was of the view that the main contact for the patients would be the defendant, and that as long as they were happy with his services they would be inclined to follow him to a competing clinic all other things being equal. Accordingly, it found on the facts that the plaintiff had a legitimate proprietary interest to protect. Clauses unreasonable because unlimited in time and scope It then considered each of the three restrictive covenants: The Court noted that the Geographical Limits Clause was not limited to the clinic at which the defendant worked, but included all other clinics set up by the plaintiff. It would cover all of the plaintiff s patients even if the defendant had not been involved in their treatment. Furthermore, there was no time limit on the period of the restriction. This suggested that, over and above protecting the plaintiff s customer base, the clause was also intended to prevent the defendant from ever competing with the plaintiff. This went further than what could be legitimately protected, and accordingly, the Court held that the Geographical Limits Clause was void as being in restraint of trade. The Court held that there had been no breach of the Non-Solicitation Clause. This decision was based on a point of procedure, and the plaintiff had been unable to show that there had actually been approaches by the defendant of its patients. However, the Court noted that even if there had been a breach, the Non-Solicitation Clause would be void as it was unlimited in duration

6 The Non-Dealing Clause was also struck down for the same reason. While the Court considered the plaintiff s argument that the clauses could be saved by being read down, it held that it would not do so. Comment Court places onus on employers to draft reasonable clauses The importance of careful drafting of restrictive covenants was stressed by the Court in Smile Inc Dental Surgeons Pte Ltd v Lui Andrew Stewart. It stated: If employers want to protect their trade connections or pool of clients, customers or patients then they would do well to draft a reasonable restraint of trade provision rather than to try and get the maximum protection which their employees will agree to. The discretionary severance approach will only encourage employers to try their luck by initially imposing the maximum protection they can get an employee to agree to and then to rely on a reading down of the provision when confronted with the likelihood of an unfavourable result in court. Moreover, not every employee will have the courage or resources to resist the threats of an employer to comply with a restraint of trade provision. It is clear therefore that when including restrictive covenants in employment contracts, the onus will be on employers. They should hence carefully consider the type of interests to be protected and ensure that the breadth of the clause does not go further than is needed to protect those interests. If you would like information on this or any other area of law, you may wish to contact the partner at WongPartnership that you normally deal with or contact any of the following partners: JENNY TSIN Joint Head Employment Practice DID: jenny.tsin@wongpartnership.com Click here to see Jenny s CV. VIVIEN YUI Joint Head Employment Practice DID: vivien.yui@wongpartnership.com Click here to see Vivien s CV

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