COURT OF APPEAL DISCUSSES DOCTRINE OF RESTRAINT OF TRADE IN TWO RECENT CASES

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1 AUGUST COURT OF APPEAL DISCUSSES DOCTRINE OF RESTRAINT OF TRADE IN TWO RECENT CASES The Singapore Court of Appeal recently issued decisions in 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 [2012] SGCA 42, the clause in question stipulated that the employee would forfeit his right to receive accrued but deferred bonus payments if he competed with the former employer after leaving. In Smile Inc Dental Surgeons Pte Ltd v Lui Andrew Stewart [2012] SGCA 39, the employee had been subjected to restrictive covenants limiting post -termination competition. This Update looks at both decisions. Background: Restraint of Trade Enforceability of 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. The leading case on restrictive covenants 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 three-fold test: Is there a legitimate proprietary interest to be protected? Is the restrictive covenant reasonable in reference to the interests of the parties? Is the restrictive covenant reasonable in reference to the interests of the public?

2 AUGUST Facts of Mano Vikrant Singh v Cargill TSF Asia Pte Ltd Cargill s incentive award plan In this case, the appellant, Mano Vikrant Singh ( MVS ) worked at Cargill TSF Asia Pte Ltd ( Cargill ) as a senior trader. Cargill 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. Forfeiture of incentives if work for competitor 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 MVS leaves to set up a competing company After working for Cargill for about two years, MVS resigned to work for a company that he had set up. Cargill 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 MVS. In total, the amount outstanding as Deferred Incentive Payments was US$1,741,894 excluding accrued interest. MVS sued for the outstanding Deferred Incentive Payments, and argued that the Forfeiture Provision was void as being in substance a restraint of trade clause. High Court Decision High Court holds that clause not a restraint In the High Court, the Judge held that the Forfeiture Provision was not in restraint of trade. The Court noted that as the clause did not prohibit MVS from competing with Cargill there was no compelling public policy that required the court to intervene. The effect of such clauses was to operate as a financial disincentive for the employee to compete after he leaves the employer. However, the Judge held that if he was wrong in his decision that the Forfeiture Provision was not in restraint of trade, he would have held in any event that the clause failed the test of reasonableness. (For more on the High Court decision, please see our update, Restrictive

3 AUGUST Covenants Considered in Two Recent High Court Cases ). Court of Appeal Decision In a landmark decision, the Court of Appeal disagreed with the High Court on whether the Forfeiture Provision was in restraint of trade, holding that it was. This is the first case in Singapore to look at the issue of whether clauses such as the Forfeiture Provision are a restraint of trade. The Court of Appeal decision now clarifies the law in this area in Singapore. Nature of the Forfeiture Provision Court must look at how the clause operates The Court noted that the Forfeiture Provision was, on its face at least, different in nature from a traditional restraint of trade clause as it was not an outright prohibition against competition by the employee but a clause which caused the employee to forfeit certain benefits if he chose to compete with the employer. However, framing a clause to look like a disincentive did not shield it from the application of the restraint of trade doctrine. What needed to be considered was the true nature of the Forfeiture Provision: what the benefit was given for, as well as why, and in what circumstances it could be withheld or taken away. Comparison with Payment-for- Loyalty clauses In deciding whether the Forfeiture Provision amounted to a provision in restraint of trade, the Court of Appeal compared it to Payment-for-Loyalty clauses which have been considered acceptable and not amounting to a restraint of trade. Such provisions provide that if the employee continues in the employment of the employer, he will receive an additional payment for his loyalty. Forfeiture Provision operated as a restraint The Court observed that, conversely, the Forfeiture Provision contemplated a situation where the Deferred Incentive Award had already vested in MVS as a legal entitlement. The heading of the clause itself, Forfeiture Provision made this clear if the Deferred Incentive Award had not already vested in MVS there would be nothing to forfeit. Put simply, the Forfeiture Provision operated to restrain MVS from leaving the employment of Cargill to join a competitor by way of a threat to forfeit a large financial award which had already vested in MVS should he choose to do so. Through this process of comparison, the Court identified two key differences between the Forfeiture Provision and Payment-for-Loyalty clauses that led it to conclude that the Forfeiture Provision was in restraint of trade. The two differences, in brief, were as follows:

4 AUGUST Employee required to give up vested rights Clause applies to post-employment conduct The Forfeiture Provision operated on bonus monies for work done which had already been declared in favour of the employee and the rights to which had already vested in the employee. Loyalty-for-Payment clauses, on the other hand, concern additional payment to be received for loyalty, and the employee has hitherto not done anything that entitles him to such payment. They therefore do not concern rights that have already vested in the employee. The Forfeiture Provision would have effect in respect of conduct occurring after the termination of employment. Specifically, it would operate only if the employee engaged in the prohibited conduct post-employment. This was significant to the Court as it indicated that the clause was an attempt to control the employee s conduct after he had left the control of the employer. On the other hand, Payment-for-Loyalty clauses take effect in respect of continuing conduct during the period of employment. They do not constraint activity once the period of employment is over. Motivating cause of Forfeiture Provision is restraint The two differences point to the different manner of operation of the two types of clauses. According to the Court, the Forfeiture Provision threatened to take away from the employee what was his if he engaged in certain conduct, and hence the motivating cause for the employee s behaviour should be properly characterised as a restraint. Payment-for-Loyalty clauses, in contrast, offer a reward for engaging in certain conduct, and hence the motivating cause for the employee s conduct is better characterised as an incentive. Hence, even though at a very broad and superficial level, the two clauses appear to have the same economic effect (i.e., the employee is enriched by a certain amount if he behaves in a certain manner), they are very different. Clause may still pass muster if it is reasonable It is important to note, however, that the Court was not saying that all clauses in the nature of the Forfeiture Provision would be automatically invalid. Instead, once a clause such as the Forfeiture Provision is characterised as being in restraint of trade, then the Court applies the twin tests of reasonability (i.e., vis-à-vis the interest of the parties and public policy) to determine if the clause is unenforceable. Only if the clause is unreasonable on either ground will it be determined to be unenforceable. The Court s comment in this respect is particularly noteworthy: the approach we have adopted also provides employers with sufficient flexibility inasmuch as it preserves the many permutations of schemes which they can set up. For example, schemes involving straightforward loyalty

5 AUGUST payments would not constitute a restraint as such. Neither would loyalty payments which constitute a percentage of, and are in addition to, bonus payments, nor a deferred bonus scheme which is not tied to a non-compete clause. Employers could even choose to maintain the same structure as that adopted in the present case and such a scheme would still pass muster if it is reasonable. The concept of vesting is thus no more than a reiteration of the accepted concept that an individual s freedom to trade cannot be constrained, except in accordance with the twin tests of reasonableness. It does not dictate to employers what they should do in order to retain their top talent. Accordingly, as the test of reasonability is essentially one of law and fact, the same clause seen against different factual matrices could result in different conclusions, and under this test each case will need to be tested against its own facts. Clauses affecting unvested rights Another noteworthy point is the Court s comment that a clause that does not operate on vested rights in order to constrain an employee s behaviour should not automatically be viewed as incapable of being characterised as a restraint of trade. In this respect, it looked at English and Australian cases that had found clauses dealing with non-vested rights as amounting to restraints. The Court, however, refrained from reaching a conclusion on such clauses as these were not in issue before it. It is important to note, however, that merely structuring a clause to apply to unvested rights is not an automatic assurance that the court will not apply the doctrine of restraint of trade to it. Once again, the court will assess each clause on its own terms and against its factual context to determine enforceability. Court agrees that provision was unreasonable As the Court had held that the Forfeiture Provision was a clause in restraint of trade, it therefore had to consider whether it was reasonable. In respect of that question, the Court wholly agreed with the finding of the High Court that the Forfeiture Provision was unreasonable. Accordingly, it held that it was unenforceable. Facts of Smile Inc Dental Surgeons Pte Ltd v Lui Andrew Stewart Restrictive covenants in ASL s contract Smile Inc Dental Surgeons Pte Ltd v Lui Andrew Stewart dealt with the more traditional restraint of trade clauses. The respondent in this case, Andrew Stewart Lui ( ASL ) was employed by the appellant, Smile Inc Dental Surgeons Pte Ltd

6 AUGUST ( Smile ) as an associate dental surgeon. ASL s employment contract contained restrictive covenants that restricted him from, among other things: Damaging the reputation of his employer, or soliciting any of his employer s patients for himself upon leaving his employment (the Non-Solicitation Clause ); Practicing within a three kilometre radius from any of his employer s practices (the Radial Clause ); and Copying or removing any patient data or records from his employer upon leaving his employment (the Non-Dealing Clause ). Clause 16 of the employment contract also provided that ASL must not carry on or engage in any other medical or dental practice, or give any medical or dental advice for reward during his period of employment with Smile. ASL undertook preparations to compete Whilst he was still employed by Smile, ASL decided to start his own dental practice and took steps to incorporate a company, enter into a lease for premises, and commence renovation works on those premises. After ASL s departure from Smile s practice, many of Smile s patients chose to go with ASL to his new practice. Smile commenced proceedings, alleging that ASL had breached the restrictive covenants in his employment contract and alternatively that ASL had breached the implied term of the duty of good faith and fidelity as an employee. The High Court Decision High Court held that clauses were unreasonable The High Court Judge found that ASL had breached the Radial and Non-Dealing Clauses, but held that the restrictive covenants were in unreasonable restraint of trade and therefore void and unenforceable, essentially because they were all unlimited in duration. (For more on the High Court decision, please see our update, Restrictive Covenants Considered in Two Recent High Court Cases ). The Court of Appeal Decision The main issues before the Court of Appeal were whether the restrictive covenants were void for being in unreasonable restraint of trade and if so, whether they could be read down to provide for a time limitation. The Court also had to determine whether ASL s actions were in breach of his duty of good faith and fidelity to Smile.

7 AUGUST Restrictive Covenants Unreasonable as of No Fixed Duration Clause unreasonable as no fixed duration The Court held that there was a legitimate proprietary interest in the goodwill generated by the practice of medical practitioners, including dental practitioners, which might be protected by reasonably worded restrictive covenants. However, in the present case, as the restrictive covenants did not provide for any fixed duration of operation they were clearly not reasonable and as such were necessarily void and unenforceable. Blue-pencil test not applicable The restrictive covenants could not be read down by using doctrines of severance, which provide for the striking out of entire clauses in a contract, or by striking out certain parts of a clause by use of a blue-pencil test, as there was no time limit expressed in the contractual terms and therefore nothing to strike out. Whilst not necessary to make a conclusive finding in the present case, the Court noted that there were various interesting arguments from other jurisdictions that would need to be canvassed when the issue of the applicability of the doctrine of notional severance arose directly for decision before the Singapore courts. We discuss this portion of the decision in greater detail below. Court would not rewrite contract Smile also argued that, as the employment contract was negotiated and concluded in the context of ASL leaving Singapore within six years, restrictive covenants operating for two to three years would have been included had ASL made it clear he intended to remain in Singapore. Smile submitted that this prior intention should be read into the contract so as to render the restrictive covenants valid. The Court disagreed, finding that the language of the restrictive covenants was clear. What Smile was seeking to do was to introduce, in a unilateral and subjective manner, its own hypothetical intention in order to re-write the contract in its favour. Implied Term of Duty of Good Faith and Fidelity ASL s preparations were not carrying on a dental practice It is well-established that there is an implied term in the employer s favour that an employee will serve the employer with good faith and fidelity. However, in the present case the Court held that an express clause (Clause 16) in the employment contract which provided for the scope of prohibited activities during the course of ASL s employment, superseded the implied contractual term of the duty of good faith and fidelity. In the Court s view, it was clear from the evidence that ASL had not breached Clause 16 as none of ASL s acts complained of could be considered as carrying on or engaging in another dental practice.

8 AUGUST Preparatory steps are acceptable In any event, even assuming that an implied duty of good faith and fidelity was owed by ASL, the Court held that that duty had not been breached. The mere taking of preparatory steps to compete with an employer did not constitute a breach of the duty of good faith and fidelity. Whether or not steps taken by an employee could be considered preparatory to future competition or instead constitute actual competitive activity would turn on the facts of each particular case. Cascading Clauses and Notional Severance Efficacy of cascading clauses not clear As noted above, the Court in this case made various comments on the phenomenon of cascading clauses which are noteworthy. Cascading clauses are restrictive covenants that provide for an alternative variety of durations or geographical scopes, and are specifically drafted to allow the court strike out those parts that it determines to be unreasonable (a process referred to as notional severance ). The acceptance of such clauses has been mixed: the Court noted that while New South Wales has accepted the efficacy of such clauses in preserving the restrictive covenant, Canada has ruled that they do not work. Court inclines to view that such clause are not valid The Court s observations are especially noteworthy because it specifically stated that it found the reasoning of the Canadian Supreme Court on this question to be persuasive, although it stressed that it was not deciding the issue. In brief, the Canadian Supreme Court had rejected the application of notional severance for restrictive covenants in the employment context for the following reasons: Applying notional severance in these circumstances simply amounts to the court rewriting the covenant in a manner that it subjectively considers reasonable in each individual case. It invites the employer to impose an unreasonable restrictive covenant on the employee with the only sanction being that if the covenant is found to be unreasonable, the court will still enforce it to the extent of what might validly have been agreed to. Having regard to the generally accepted imbalance of power between employers and employees, to introduce the doctrine of notional severance to read down an unreasonable restrictive covenant to what is reasonable provides no inducement to an employer to ensure the reasonableness of the covenant and inappropriately increases the risk that the employee will be forced to abide by an unreasonable covenant.

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