Restrictive covenants
Review partnership law and ditch Bridge v Deacons, says Daniel Isaac
For many years it has been assumed that partnerships are able to enforce onerous restrictive covenants against departing partners. The authority for this view is the Privy Council decision in Bridge v Deacons [1984] 1 AC 705; a decision based on outdated ideas, peppered with outdated language and not even binding on the UK courts. Bridge v
Deacons is ripe for review!
When selling a business, a vendor will often be able to increase the price of that business by promising not to engage in competitive activity after he or she has sold it. It has long been established that such restrictions are likely to be enforced by the courts in the public interest.
The starting point for employees is radically different. Restrictive covenants in employment contracts are scrutinised closely and will be found to be void unless the employer can show that it has a legitimate business interest to protect and that the restrictions are no wider than reasonably necessary to protect that interest.
A partner falls somewhere between these two breeds. While partners are technically owners of businesses, in many of today's large partnerships they are not, in practice, very different from senior employees. And what of members of LLPs, many of whom are much more akin to employees than partners? Bridge v Deacons means that partners are treated more like owners than employees, but is this still appropriate?
Restrictions in Bridge v Deacons
Robin Bridge was an equity partner in Deacons, a 27-partner law firm in Hong Kong. Under the partnership agreement, he was entitled to 5 per cent of the partnership business and assets, including goodwill at a nominal value. The agreement included a restriction preventing him for five years from acting as a solicitor in Hong Kong for any person who had been a client of the firm within the three years prior to his departure (although he was permitted to deal with such clients if he moved to a government or in-house role).
Bridge was head of the IP and trademark department that dealt with approximately 10 per cent of the firm's files and generated about 4.5 per cent of the firm's turnover. He dealt only with clients who used his department and was even in a different part of the building with its own lift. He did not, therefore, know or have any special influence over the other clients of Deacons, but the agreement nevertheless sought to prevent him from acting for them.
Bridge left Deacons in 1982, receiving a substantial payment for his share of the partnership. He then set up his own practice acting for former clients of his old firm. Deacons applied for an injunction to enforce the restrictive covenant and, in a decision that would surprise many today, was successful.
Privy Council reasoning
- Counsel for Bridge argued that he had contact with less than 10 per cent of Deacons' clients and therefore had no advantage over any other solicitor in seeking to attract the business of the other 90 per cent. This was rejected by the Privy Council which pointed out that he owned, together with the other partners, the whole of the assets, notwithstanding any 'departmentalisation' of the practice.
- It was suggested on behalf of Bridge that it would have been reasonable to restrict a retiring partner from acting for clients for whom he had personally acted or for whose work he was generally responsible. Strangely, the Privy Council said that 'a restriction on those lines might well be difficult to apply' and felt that such a clause 'might work very unfairly in the case of a partner who for some reason had acted for only a small number of clients as compared with another partner with a large number of relatively small clients'.It asked: 'What of the partner who led an active social life and was instrumental in introducing a number of clients whose business did not fall within the department?'
- When it was pointed out that there was no evidence to justify a five-year period of restriction (or indeed the inclusion of anyone who had been a client within the last three years) the Privy Council replied: 'These are matters which are hardly susceptible of proof by specific evidence.' Yet in employment cases these clauses have to be justified by those seeking to enforce them. This objection can hardly stand the test of time.
- On the palpably excessive five years, the Privy Council said: 'There appears to be no reported case where a restriction which was otherwise reasonable has been held to be unreasonable solely because of its duration,' Again, in an employment situation excessively long covenants are regularly struck down (eg Scully UK Ltd v Lee [1998] IRLR 259 and Barry Allsuch & Co v Jonathan Harris (2001) QBD).
- On the question of reasonableness, the Privy Council said: 'There is a clear public interest in facilitating the assumption by established solicitors' firms of younger men as partners.' It is quite extraordinary that, as recently as 1984, the Privy Council was still using such gender specific language. Supporters of Privy Council reasoning could point out that it would be simple enough to read men as 'people' but the language used indicates how much times have changed since this decision. It must be time to have another look at not only the language but also the reasoning.
- The Privy Council cited evidence before it that Deacons would only feel able to take on new capital partners if they knew that, in so doing, they would not run the risk that such new partners would acquire a connection with their clients and then depart with that part of Deacons' goodwill. That is, of course, perfectly reasonable, but does not mean that the partners should also be prevented from dealing with clients of the firm that they had never encountered (or perhaps did not even know were clients).
- Finally, there was a question of whether it was in the public interest to preclude a solicitor from acting for a client when that client wanted him to act. The Privy Council decided there was no public policy problem. Interestingly, the UK position is in stark contradiction to the position in most US states, where a combination of state law and the 6th Amendment right to counsel of a person's choosing means a restrictive covenant is simply unenforceable against a lawyer.
An important development of recent years is the increasing size of many partnerships. At Deacons, there were 27 partners and one must wonder how much control each individual partner actually exercised. Nevertheless, each partner's degree of power was probably substantial compared with a modern firm of 50 or 100 partners where an individual's partner's influence is often very small. A firm could strategically change direction against a partner's will and yet enforce the restrictions against that partner.
If two solicitors enter into partnership with each other, each will have a reasonable bargaining position. If a solicitor is 'made up' in one of today's city practices, he or she is likely to have very little influence over the terms of the partnership deed. Of course, it is always open to the solicitor to decline partnership (just as it is open to any employee to decline an offer of employment), but the imbalance of bargaining power needs to be taken into account.
And what of LLPs? Many firms are now establishing themselves as LLPs and making employees members of the LLP simply to avoid National Insurance contributions. A challenge to the validity of 'partnership' covenants '“ and possibly to the authority of Bridge v Deacons itself '“ is quite likely to come from a junior member of an LLP.
The reason Bridge v Deacon has not yet been challenged is probably due to the practical realities of the situation. If a partnership of solicitors seeks to prevent a client from following the solicitor of his choice, the client is likely to say 'a plague on both your houses' and instruct a third firm until the departing partner and his old firm can agree a deal. When teams of solicitors move from firm to firm, a commercial deal tends to be struck and the courts are rarely troubled.
No complacency
While there is much merit in the view that, as a part owner of a business, a partner should be subject to different rules on covenant enforceability, the authority of Bridge v Deacons should not lead partnerships to be too complacent. Lengthy restrictions '“ in excess of a year '“ are likely to be unreasonable in many modern partnerships and, in the near future, someone is bound to challenge the long-held assumption that, in this area, partnerships can get away with almost anything.
Daniel Isaac is a principal at Withers LLP