Forfeiture Clause In Incentive Award Plan Did Not Constitute Restraint In Trade

Forfeiture Clause In Incentive Award Plan Did Not Constitute Restraint In Trade Introduction It is common today for employers to incorporate an incentive award plan into their employment contracts, or have a separate agreement with the employee that stipulates the terms and conditions of payments of bonuses. An incentive award plan typically comprises a cash component and a deferred payment component. A common term in incentive award plans is a forfeiture clause which provides that the deferred payment of an award would be forfeited if the employee competes with the employer within a certain period after the employee's separation from service. In Mano Vikrant Singh v Cargill TSF Asia Pte Ltd [2011] SGHC 241, the Court was confronted with the novel issue of whether this kind of forfeiture provision constitutes a restraint of trade. Steven Chong J ruled that the forfeiture provision was neither in form and substance in restraint of trade. The Court followed the majority view in the US to the effect that the restraint of trade doctrine does not apply to forfeiture-for-competition clauses because they do not prohibit the employees from competing with the employers. The subject forfeiture provision merely contractually defined what the employee might forego should he decide to compete upon resigning from work. In other words, the provision merely operated as a "financial disincentive" for the employee to compete after leaving the company. The Court adopted the Employee Choice Rationale that the majority view of the US courts espouses in ruling that the restraint of trade doctrine does not apply to forfeiture clauses. The Employee Choice Rationale suggests that an employee is a rational individual who is presumed to weigh the costs and benefits of competing with his employer. As a rational individual, he can choose to avail of his entitlement to the incentive by refraining from competition, or lose the award by exercising his right to compete. It must be noted that the US cases holding that the restraint of trade doctrine applies to forfeiture-forcompetition clauses generally apply the English reasoning that the clauses are in substance, restraints of trade because they curtail competition. This was not followed by the Court in resolving the instant case. The Court also emphasised here that the mere fact that a certain clause is found to be in restraint of trade does not ipso facto render it unlawful. The employer must first justify its reasonableness before the court can uphold its validity. 1 Rajah & Tann LLP

Brief Facts (1) The Plaintiff joined Cargill Group of companies as a trader and analyst. He held several other positions within the Group and later moved over to the Defendant, part of the Cargill Group as a senior trader. (2) Aside from the Employment Contract that the Plaintiff had signed, he also contemporaneously entered into a non-compete agreement ("Non-compete Agreement") prohibiting him from competing with Cargill Group's Trade and Structured Finance ("TSF") business for a stipulated period. (3) The Defendant had an individual incentive award plan ("Incentive Award Plan"), the terms and conditions of which ("Incentive Award Plan T&Cs") provided for a cash component of the award and a deferred payment component ("Deferred Incentive Payments"). (4) The Incentive Award Plan T&Cs contained a forfeiture clause, providing that the deferred payments would be forfeited if the Plaintiff competed with the Defendant within a period of two years from the date of his separation from service ("Forfeiture Provision"). Unlike the Non-Compete Agreement, the Plaintiff was not obliged to accept the Incentive Award Plan T&Cs, but the Deferred Incentive Payments would not be processed unless the Plaintiff signed the Incentive Award Plan T&Cs. (5) The Plaintiff was awarded a bonus and the cash component was paid to him in accordance with the Incentive Award Plan T&Cs. A substantial amount remained outstanding on the deferred component of the bonus. (6) While still in the employ of the Defendant and shortly after his bonus was awarded, the Plaintiff incorporated a company, X. He thereafter resigned from the Defendant. (7) The Defendant claimed that the Plaintiff, in establishing a competing business in X, had breached the Forfeiture Provision and therefore was not entitled to the remaining Deferred Incentive Payments. Issues The Court had to, inter alia, determine - (i) whether the Forfeiture Provision was in substance a restraint of trade (ii) if so, whether the restraint imposed by the Forfeiture Provision was reasonable 2 Rajah & Tann LLP

Ruling of the Court The Court held that the Forfeiture Provision was neither in form and in substance in restraint of trade. Types of post-termination restraints The Court at the outset identified the three types of clauses which appear to provide some form of post-termination restraints: (i) Traditional Restraint of Trade ("ROT") Clauses; (ii) Forfeiture-for- Competition Clauses; and (iii) Payment-for-Loyalty Clauses. The first type of clause mandates an employee not to compete with his employer for a stipulated period following the termination of employment. The Non-compete Agreement is an example of a Traditional ROT Clause. The second type of clause involves the forfeiture of certain benefits if an employee competes with his employer. The Forfeiture Provision is a Forfeiture-for-Competition Clause. The third type of clause forfeits benefits if an employee resigns. This is so even if the employee does not compete with the employer upon his resignation. Rationale behind the restraint of trade doctrine Forfeiture-for-Competition Clauses are largely treated in the same vein as Traditional ROT Clauses since they are viewed to have the same effect of deterring employees to compete. It is therefore apposite to revisit the rationale for the ROT doctrine to understand why policy considerations should be engaged in the case of Forfeiture-for-Competition Clauses. The public policy underlying the doctrine of restraint of trade was considered in Man Financial (S) Pte Ltd (formerly known as E D & F Man International (S) Pte Ltd) v Wong Bark Chuan David [2008] 1 SLR(R) 663 ("Man Financial"), where the Court of Appeal held that the doctrine seeks to vindicate the right of freedom of trade while balancing the freedom of contract. It seeks to balance the conflicting but legitimate interests of the employee to use and exploit his expertise and knowledge on one hand, and the state in securing an environment in which freedom of trade can flourish on the other hand. UK and Australian Jurisprudence on Forfeiture-for-Competition Clauses The prevailing view in the UK and Australia is that a stipulation in an employment contract is in restraint of trade if it tends to diminish the employee's prospect of employment. Leading English cases have held that Forfeiture-for-Competition Clauses are essentially restraints of trade as their effect does not differ from an agreement not to compete. Based on this view, the effect of Forfeiturefor-Competition Clauses is curtailment of competition. It must be noted at this juncture that the mere fact that a particular clause is found to be in restraint of trade does not automatically render it unlawful. The employer must establish that it is reasonable before the court can uphold its validity. 3 Rajah & Tann LLP

Majority view in the US: the Employee Choice Rationale The legal position in the United States on whether Forfeiture-for-Competition Clauses are restraints of trade is divided. Suffice it to say that the majority view in the US is that the restraint of trade doctrine does not apply to Forfeiture-for-Competition Clauses. This is so because the Forfeiture-for- Competition Clauses do not prohibit the employee from competing with the employer. It merely operated as a "financial disincentive" for the employee to compete after resigning from work. In such a situation, the employee has a choice in determining whether he wants to compete, and, as a rational actor, is presumed to have weighed the costs and benefits (or the advantages and disadvantages) of competing with his former employer ("Employee Choice Rationale"). The commentary in one of the leading treatises on contract law, Corbin on Contract vol 15 (LexisNexis, 2003) is enlightening: "In cases involving this scenario [ie deferred compensation plan akin to the Incentive Award Plan], courts refuse to subject the arrangement to a reasonableness analysis because the forfeiture does not prevent the employee from competing. Rather, the employee has the choice of competing or keeping the deferred compensation benefits. As one court stated: "The provision for forfeiture here involved did not bar plaintiff from other employment. He had the choice of preserving his rights under the trust by refraining from competition with [his employer]... or risk forfeiture of such rights by exercising his right to compete with the [employer]"." (Emphasis supplied; phrase in brackets added) The US cases holding that the restraint of trade doctrine applies to Forfeiture-for-Competition Clauses generally apply the English doctrine that the clauses are, in substance, restraints of trade. Forfeiture Provision did not constitute restraint in trade The Court followed the majority view of the US in holding that the Forfeiture Provision did not amount to restraint of trade. The doctrine on restraint of trade did not apply because the provisions did not prohibit the Plaintiff from competing with the Defendant. The Forfeiture Provision merely contractually defined what the Plaintiff might forego should he decide to compete upon leaving the employment of the Defendant. In this case, the Plaintiff actually had a choice not to accept the Incentive Award Plan T&Cs, an agreement that was separate and distinct from the Employment Contract and the Non-compete Agreement. Given this, when he left the Defendant, the Plaintiff, as a rational actor, would have made a calculated business decision that it would be more advantageous for him to forfeit the deferred bonus. Indeed, there was no compelling reason for the Court to intervene on the ground of public policy since there was no restraint of trade to speak of in the first place. To hold the Forfeiture Provision as in substance a restraint of trade would attach unjustifiable weight to the right of trade at the expense of the equally important right of freedom of contract. 4 Rajah & Tann LLP

Forfeiture Provision not reasonable In view of the Court's holding that the Forfeiture Provision was not in restraint of trade, there was therefore no need to consider whether the provision was reasonable. However, for the sake of completeness and since full submissions were made by both parties, Steven Chong J proceeded to express his views on this issue. Had it been determined that the Forfeiture Provision constituted restraint of trade, the Court would have found it to be unreasonable and hence unenforceable. In order for the court to rule that a restraint of trade clause is reasonable, it must be shown to be reasonable with respect to the interests of both the parties and the public (Man Financial, citing Thorsten Nordenfelt Guns and Ammunition Company, Limited [1984] AC 535). In applying this principle, the court will take into account the geographical scope or area of restraint and the duration of the restraint. The employer must also have a legitimate proprietary interest that it seeks to protect by imposing a restraint of trade. Although the Defendant had a legitimate interest to protect (one of which was its worldwide business connections), the extent of the restraint was not reasonable for the following reasons: (i) Period of restraint - The duration of the Non-compete Agreement was one year, while that of the Forfeiture Provision was two years. There was no compelling reason why the Defendant's legitimate proprietary interest required protection beyond the period for which it already received protection under the Non-compete Agreement. (ii) Geographical area - The Forfeiture Provision had no geographical limit, while the restriction under the Non-compete Agreement was limited to countries in which the Defendant had an actual place of business. (iii) Scope of activities prohibited - The Forfeiture Provision covered activities that were beyond TSF business and hence was wider than necessary to protect the Defendant's legitimate proprietary interest. Conclusion The Court's decision in this case is a departure from the UK and Australian position that Forfeiturefor-Competition Clauses are, in substance, restraints of trade. It is the Court s view that the Forfeiture Provision did not inhibit competition and hence the restraint of trade doctrine did not apply. It adopted the Employee Choice Rationale which is followed by the majority of US cases to explain that the Plaintiff was a rational actor who had choices and could weigh the costs and benefits of his actions. 5 Rajah & Tann LLP

With this decision touching on a very important issue of employment law, the stakeholders in the employment market should now be more aware of the implications of their post-termination restraints. They must be able to distinguish the provisions to which the doctrine of restraint of trade applies from those to which the doctrine does not apply. Until and unless this ruling is challenged in the Court of Appeal, and the apex court eventually rules otherwise, the rationale in this case will be the law on disputes involving similar provisions with the same factual matrix. Contacts Francis Xavier, SC Head, Disputes Practice D (65) 6232 0551 F (65) 6428 2111 francis.xavier@rajahtann.com Abdul Jabbar Partner D (65) 6232 0465 F (65) 6428 2191 abdul.jabbar@rajahtann.com Please feel free to also contact the Knowledge and Risk Management Group at eoasis@rajahtann.com Rajah & Tann LLP is one of the largest law firms in Singapore and Asia, with representative offices in Shanghai, Vientiane, Ho Chi Minh City and Bangkok, as well as an associate office (Kamilah & Chong) in Kuala Lumpur. As a full service regional law firm, our knowledge, resources and insight can be your business advantage. Rajah & Tann LLP is firmly committed to the provision of high quality legal services. It places strong emphasis on promptness, accessibility and reliability in dealing with clients. At the same time, the firm strives towards a practical yet creative approach in dealing with business and commercial problems. The contents of this Update are owned by Rajah & Tann LLP and subject to copyright protection under the laws of Singapore and, through international treaties, other countries. No part of this Update may be reproduced, licensed, sold, published, transmitted, modified, adapted, publicly displayed, broadcast (including storage in any medium by electronic means whether or not transiently for any purpose save as permitted herein) without the prior written permission of Rajah & Tann LLP. Please note also that whilst the information in this Update is correct to the best of our knowledge and belief at the time of writing, it is only intended to provide a general guide to the subject matter and should not be treated as a substitute for specific professional advice for any particular course of action as such information may not suit your specific business and operational requirements. It is to your advantage to seek legal advice for your specific situation. In this regard, you may call the lawyer you normally deal with in Rajah & Tann LLP or e-mail the Knowledge & Risk Management Group at eoasis@rajahtann.com. 6 Rajah & Tann LLP