Lawyers have to deal with many issues when businesses are reorganising or making acquisitions but one that can be overlooked is protecting a firm’s ability to enforce restrictive covenants. This is particularly important in industries in which employees’ personal relationships carry significant value. In extreme cases it can influence the structure of a transaction but in every case it is something that the legal team should bear in mind when considering how best to approach the deal.
There are well-known challenges where a business is being purchased out of an insolvency situation and the provisions of TUPE have, in the past, been used successfully to effectively circumvent restrictive covenants and notice periods through strategically timed objections to the transfer, and subsequent arguments that the residual (insolvent) entity does not have any legitimate interest to protect and so is unable to enforce the covenants it had in place. Even where the TUPE transfer does not involve an insolvency event, the transferor business may not be in a position (either commercially or legally) to enforce a restrictive covenant if the business which the covenant was designed to protect has moved to a purchaser or transferee.
Assuming that these considerations do not justify restructuring the transaction to ensure that some residual interest is left in the transferor business or the circumstances make that impossible, businesses sometimes try to address this challenge through the use of assignments (known as assignations in Scotland). If any of the affected employees are located in Scotland it is important for practitioners to be aware of the law relating to assignation and some of the issues that have come up when trying to enforce assignations of obligations contained in employment contracts. There are two main issues for practitioners to consider in this area: firstly, whether the restriction itself is capable of being transferred or whether it only binds the original parties to the contract and secondly how the transfer itself is to be carried out.
ASSIGNATION OF RESTRICTIVE COVENANTS
Scots law recognises the principle of privity of contract. In the ordinary case the only persons whose rights and liabilities are affected by a contract are the contracting parties. However, certain rights and liabilities can be assigned and the benefit arising under a contract is assignable in Scots law, in the absence of any express provision to the contrary (see Aurdal v Estrella [1916]).
The question of whether the right to enforce a restrictive covenant may be assigned, however, is one which has caused the Scottish courts some trouble. In contrast to the situation in England, it is by no means clear that a Scottish court will accept that an employee’s post-termination obligations (restrictive covenants) forming part of the contract with their employer could validly be assigned by their employer (the cedent) to a third party (the assignee) to whom the business undertaking is to be transferred under TUPE and into whose employment the employee would transfer, should there be no objection made prior to the transfer. In this area, it has been observed that there is nothing ‘that can be termed a general rule of law’ (Rodger v Herbertson [1909]). Instead, the courts will examine the terms of each individual restriction in order to determine whether it is assignable.
In William Fraser v Renwick [1906], for example, a taxi business was sold by its owner to another businessman. The sale agreement contained a clause, restricting the original owner from carrying on a taxi business in competition with the assignee. The assignee subsequently assigned the benefit of this agreement to another party (who had bought the assignee’s business interests). In the Outer House of the Court of Session, the restriction was considered to be capable of being assigned.
William Fraser shows that there is no general rule that contractual restrictions cannot be assigned. The Scottish courts, however, have set limits on what may be assigned to third parties. Contracts involving something more than payment or delivery of a particular thing may not be assignable if it is a matter of reasonable inference that one party entered into the contract in reliance on the qualities possessed by the other – where the contract involves delectus personae (see Gloag and Henderson the Law of Scotland (10th ed) 11.17 and 1.18). The question for an employer (or assignee) is whether the restriction which binds the employee is one which involves delectus personae or whether it can be said that the benefit of the restriction can be transferred.
Each case in this area depends on its own facts. Nevertheless, it is clear that the courts will examine closely the terms of each agreement to see whether delectus personae can be detected. Equally, delectus personae may be present in relation to certain parts of a contract, but not to others. Three factors in particular emerge from the cases as crucial to this exercise:
- whether the effect of assignation is to alter the nature of the original restrictions;
- whether the employee consented to the possibility of assignation; and
- whether the terms of the contract indicate that the parties to theoriginal contract intended that the agreement was to bind them only and not any assignees.
In Rodger v Herbertson, for example, the Inner House of the Court of Session considered the restrictions contained in the sale of a medical practice. The Court held that these were clearly of a ‘personal character’ only. This was not a result of the restrictions themselves, but rather because another term of the agreement bound the departing partner to ‘use his influence’ in favour of the purchaser. This was a sign that the contract was intended to be between the particular parties only, and the restrictions could not be assigned.
The leading Scottish case in this area remains the decision of the Inner House in The Berlitz School of Languages v Duchene [1903]. In Berlitz, the employee was a language teacher who had worked for the businessman Georges Abraham. Mr Abraham subsequently transferred his language teaching business to the Berlitz School of Languages. This transfer was held by the Inner House of the Court of Session not to have included the restriction in the employee’s contract from competing with Mr Abraham’s schools. This was because Abraham’s business had passed to a larger company, and to allow the restrictions to transfer would have been to place the employee ‘under a more serious disability… than he intended to undertake’. Rather than a restriction on competing with Abraham’s business, the restriction would have prevented him competing with Berlitz’s larger organisation. Further, the employee had not provided any form of consent to the assignation.
The principles set out in Berlitz and Rodger have not been recently considered by the Scottish courts. Nevertheless, in one recent (unreported) Scottish case, Lord Malcolm expressed the view that the presence of delectus personae in the contract of employment makes the notion of assignation of benefit unattractive. Employers and assignees wishing to rely on the assignation of post-termination agreements, therefore, should check the restrictions to see whether their ‘personal’ nature means that they cannot, in fact be assigned.
It is important to emphasise, however, that delectus personae is something which is inferred from the contract itself: did the parties intend that only the original parties to the contract should be bound by its terms? This means that it is possible for an employer and employee to agree in the contract that delectus personae should not apply to all (or part) of an employment contract, or that assignation may take place (subject, perhaps to certain conditions). This is an approach which has received judicial support in Scotland. In Methven Simpson v Jones [1910], restrictions contained in an agreement provided that, ‘The employer, his executors or administrators shall be entitled to assign the benefit of this agreement.’ This was held to provide sufficient consent to assignation and the assignee was entitled to rely on the restrictions. Care should be taken, however, that consent is given sufficiently clearly. In Rodger v Herbertson, for example, a restriction which was also in favour of the employer’s ‘successors’ was held not to contain consent to assignation by the employee. In addition, any assignation clause should comply with the general principles of reasonableness in relation to restraint of trade clauses.
If, however, assignation is possible then it is important to ensure that the right steps are taken to complete the assignation.
FORM OF ASSIGNATION AND PROCESS FOR INTIMATION
No particular form of assignation need be used. At common law the usual form of transfer of property such as a debt was a mandate. The Transmission of Moveable Property (Scotland) Act 1862 provides some short form styles of assignation, but, ‘words which give authority or directions, which, if fairly carried out operate a transference, are sufficient to make an assignation’ (See Carter v McIntosh (1862)).
As between the cedent and the assignee the execution and delivery of the assignation is sufficient to give the transferee a valid right (see Thome v Thome (1632)).
But for the purposes of giving the assignee a right effective against all parties, intimation of the assignation to the person owing the obligation (here the employee) is necessary.
In addition, (and most importantly in the present circumstances) intimation is necessary to complete the assignee’s right (see Stair, The Institutions of the Law of Scotland III,I,6; Erskine, An Institute of the Laws of Scotland, III,v,3; Bell, Commentaries on the Law of Scotland and Principles of Mercantile Jurisprudence, ii,16; and Liquidator of Union Club v Edinburgh Life Assurance Co(1906)). Intimation is the point from which the passing of the right is dated. So in the present circumstances, the assignation of the restrictive covenants would not be completed until it had been intimated to the employee.
As with the form of assignation, there is no single specified form of intimation. The Transmission of Moveable Property (Scotland) Act 1862 provides two forms. These are:
- delivery by a notary of a certified copy of the assignation, or
- transmission by the holder of the assignation or their agent of a certified copy by post.
Clearly, there could be evidential difficulties in proving that an employee had received a certified copy of the assignation by post. The Act indicates that a written acknowledgement by the employee will be sufficient evidence but that this may not be possible in a situation in which the employee is not keen to co-operate.
Other forms of intimation are available at common law (public or judicial acts – for example, where a registered lease is assigned, intimation by registration of the assignation in the Land Register would complete the intimation and notice of the assignation may be accepted as having been given by the raising of an action against the debtor, founding on the assignation). However, none of these is likely to work with a recalcitrant and influential employee who wants to join a competitor and take the benefit of their relationships and contacts with them.
In modern practice (though not strictly in accordance with the 1862 Act), intimation is usually made by the assignee sending a notice of assignation and providing a copy of the assignation itself, by registered post or by personal service by sheriff officers (the Scottish equivalent of process servers). Intimation of an assignation by formal writing in a manner falling short of the 1862 Act’s requirements was held to be valid in Libertas Kommerz GmbH v Johnson [1977]. This, however, raises the same problem of evidence: if the employee refuses to acknowledge receipt of the assignation, the employer seeking to rely on the covenants may have considerable difficulty showing that they have had their benefit validly assigned to them. If there was urgency in having the assignation intimated, one option would be to have a notice of assignation and a certified copy of the assignation handed over personally to the employee by sheriff officers, and to have the notice acknowledged by the employee in writing. If budgets allowed, then delivery by a Scottish notary public is clearly compliant with the 1862 Act and is another possible option.
Given the underlying statutory consistency between Scots and English employment law, practitioners on both sides of the border could be forgiven for assuming that HR matters do not need separate advice and in many cases this is correct. The distinct legal system in Scotland and the particular differences around our law of property do, however, mean that careful thought should be given to whether or not Scots advice is needed on a particular transaction if there are employees within the Scottish jurisdiction.