England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		25/02/2011

Peter Smith J:

INTRODUCTION

1. This is a trial of a issue of law directed by Chief Master Winegarten on 10th February 2011 as follows:-

"there be a trial of the following issue of law, namely whether the Claimant is able, as a matter of law, to sever the definition of "Restricted Area" in clause 21.1.1 of the Franchise Agreements dated 22nd January 2007 so that the definition is limited to mean "the Territory". "

BACKGROUND

2. The Claimant is a company engaged in the business of the manufacture, sale and supply of franking machines, folding machines and postage scales and the provision of maintenance services for them.
3. The First and Second Defendants were at all material times directors of a company called FP Central Ltd ("FPCL"). It began its commercial relationship with the Claimant in 2002 but latterly entered in to two Franchise Agreements dated 22nd January 2007 for Coventry and Birmingham. The terms were the same for each.
4. The First and Second Defendants by virtue of the terms of the Franchise Agreements ("the Franchise Agreements") provided at clause 22.1.5 an indemnity in respect of the obligation of FPCL to pay the Claimant.
5. The Claimant contends that FPCL failed to pay payments as required under the Franchise Agreements so that it owed the Claimant by September 2009 the sum of £166,811.49. Accordingly it consequently gave notice under clause 18.1.2 to terminate the Franchise Agreements with effect from 9th October 2009. FPCL went in to Administration on 20th October 2009.

THE CLAIM

6. The Claimant claims the sum due from FPCL to it under the indemnity provided by the First and Second Defendants. They have not paid any sum.
7. In addition the Claimant claims damages for breach of post termination covenants contained in the Franchise Agreements. It also claims that the Third and Fourth Defendants procured breaches of the termination covenants as set out in the Particulars of Claim.
8. The Defendants contend that FPCL was trading profitably and has been deprived of future profits in the region of £2-3m by reason of it wrongfully terminating the Franchising Agreements. They also deny they are in breach of the post termination covenants and state that they are unenforceable in any event.

POST TERMINATION COVENANTS

9. The post termination covenants are as follows:-

"21. POST-TERMINATION COVENANTS

21.1 The Franchisee agrees that it shall not for the period of one year after the expiration or termination of this agreement (howsoever arising) whether itself or together with any other person firm or company directly or indirectly:-

21.1.1 be engaged interested or concerned in the Restricted Area in any capacity in any business venture which is competitive with the Business as previously carried on pursuant to this agreement (or with the business in the Restricted Area of any other franchisee, dealer or distributor of the Franchisor). For the purpose of this clause 21 the "Restricted Area" means the Territory, the territory (in the UK) of any other franchisee of the Franchisor carrying on the Business and any other territory (in the UK) covered (in relation to the supply of Products) by the Franchisor and/or any dealer or distributor of the Franchisor;

21.1.2 be engaged interested or concerned in the Restricted Area in the supply of the Products or any goods competitive with the Products;

21.1.3 solicit in the Restricted Area customers or former customers of the Business (being persons who are at the date of termination a customer of the Business or who have been a customer of the Business during the period of 12 months prior to termination, and such customers shall include any person to whom Products have been supplied by the Franchisor pursuant to this agreement) for the purposes of supplying them with goods competitive with the Products nor divert or seek to divert any custom (for Products) in the Restricted Area from the Franchisor or any other franchisee, dealer or distributor of the Franchisor nor to solicit any of their respective customers for Products;

21.1.4 employ or seek to employ any employee who is at termination employed by the Franchisor or any other franchisee of the Franchisor nor otherwise directly or indirectly induce or seek to induce any such person to leave his or her employment.

21.2 The Franchisee shall procure that none of its employees (involved to any material extent in the sales and/or marketing of the Products) senior managers or directors (including without limitation the Individual(s)) shall: (a) for a period of one year after the expiration or termination of this agreement howsoever arising, or (b) in the case that any such person ceases to be connected with the Franchisee during the period of this agreement, for a period of one year after he ceases to be so connected:-

21.2.1 be directly or indirectly engaged interested or concerned in the Restricted Area in any capacity in any business venture which is competitive with the Business as previously carried on pursuant to this agreement or with the business in relation to the Products in the Restricted Area of any other franchisee, dealer or distributor of the Franchisor;

21.2.2 be directly or indirectly engaged interested or concerned in the Restricted Area in the supply of the Products or any goods competitive with the Products;

21.2.3 directly or indirectly solicit in the Restricted Area customers or former customers of the Business (being persons who are at termination (or as the case may be at the date upon which such person ceased to be connected as aforesaid) a customer of the Business or who have been a customer of the Business during the period of 12 months prior to termination (or as the case may be the date upon which such person ceased to be connected as aforesaid) and such customers shall include any person to whom Products have been supplied by the Franchisor pursuant to this agreement) for the purposes of supplying them with goods competitive with the Products nor divert or seek to divert any custom for Products in the Restricted Area from the Franchisor or any other franchisee, dealer or distributor of the Franchisor nor to solicit any of their respective customers for Products;

21.2.4 employ or seek to employ any employee who is at termination (or as the case may be at the date upon which such person ceased to be connected as aforesaid) employed by the Franchisor or any other franchisee of the Franchisor nor otherwise directly or indirectly induce or seek to induce any such person to leave his or her employment.

AND the Franchisee shall put and keep in place contracts with its employees senior managers and directors including appropriate and enforceable restrictive covenant provisions to give effect to the foregoing and shall fully enforce the same.

21.3 The Franchisee agrees that the provisions of clauses 8.6 and 21 shall survive termination or expiration of this agreement.

10. I should also make reference to clause 33 of the Franchise Agreement which provides as follows:-

"33 SEVERANCE

33.1 Each of the restrictions and provisions contained in this agreement and in each clause and sub-clause shall be construed as independent of every other restriction and provision and each shall be capable of being severed without prejudice to the remaining provisions of this agreement, subject to clause 33.2. It is nevertheless agreed that if any of the restrictions or provisions contained in this agreement shall taken together or separately be held to be void or ineffective for any reason but would be held to be valid and effective if part of the wording were deleted, or the period or area of application be reduced, that restriction shall apply with such deletions or with such reduced period or area of application as may be necessary to make it valid and effective.

33.2 In the event that any restriction or provision of this agreement shall be held to be invalid and/or unenforceable by a court of law or any other competent authority in a way in which in the sole opinion of the Franchisor materially adversely affects the right of the Franchisor to receive payment of fees or other remuneration or the terms on which the Franchisor supplies goods or services to the Franchisee or any territorial exclusivity conferred hereunder or the Method or the Business or the Trade Name then the Franchisor without any liability whatsoever shall be entitled to terminate this agreement by notice in writing to the Franchisee to that effect and in such circumstances the provisions of clauses 20 and 21 shall apply."

OBSERVATIONS

11. Clause 21.1.1 is what is commonly called an area covenant and prevented FPCL from competing with the Business as defined for a period of 1 year in the "Restricted Area" for the purpose of clause 21.
12. Clause 21.1.2 prevented FPCL from being engaged in the supply of the Products or any goods competitive with the Products (as defined) and clause 21.1.3 is in large a non solicitation clause for a period of 12 months.
13. The First and Second Defendants agreed to comply with these provisions as well (clause 22.1.4).

RESTRAINT OF TRADE

14. The Claimant acknowledges that the area covenant contained in clause 21.1.1 is too wide, thus is a restraint of trade and is thus unenforceable. The reason for that concession is that the extension of the area covenant to the territory of any other franchisee and any other territory in the United Kingdom in relation to the supply of the products by the Claimant and any dealer or distributor of the Claimant is too wide. It proposes (as appears in this judgment) to apply the blue pencil test and strike out the words in clause 21.1.1 after the word Territory. "Territory" is defined as being various postcodes. That was the area that FPCL was given the right to trade under the Franchise Agreements.
15. Conversely the Defendants acknowledge that 21.1.1 would not be in restraint of trade if the definition of "Restricted Area" was limited to the Territory (as defined).
16. Both parties agree that the non solicitation clause is valid (clause 21.1.3) despite the fact that it refers to the Restricted Area (subject to the application of the blue pencil test) with the current extended area. It is important therefore to appreciate that both parties acknowledge this clause is valid even if it extends to the wider area in clause 21.1.1.

APPLICABLE TESTS

17. There are two basic principles namely the court (1) will not make a new contract for the parties; and (2) will not sever the unenforceable parts of a contract unless it accords with public policy to do so (Chitty on Contracts volume 1 paragraph 16-196).
18. The applicable test was approved by the Court of Appeal in Beckett Investment Management Ltd & Ors v Glyn Hall & Ors [2007] EWCA Civ 613 where Kay LJ at paragraph 40-42 said this:-

"In a number of more recent first instance decisions, a threefold test has been applied. In the employment context, its origin is to be found in Sadler v Imperial Life Assurance Company of Canada Ltd [1988] IRLR 388. Mr P J Crawford QC, sitting as a Deputy Judge of the High Court said (at paragraph 19):

"… a contract which contains an unenforceable provision nevertheless remains effective after the removal or severance of that provision if the following conditions are satisfied:

(1) the unenforceable provision is capable of being removed without the necessity of adding to or modifying the wording of what remains;

(2) the remaining terms continue to be supported by adequate consideration;

(3) the removal of the unenforceable provision does not so change the character of the contract that it becomes 'not the sort of contract that the parties entered into at all'."

19. It seems to me that requirement (1) is derived from the well known decision of Attwood v Lamont [1920] 3KB 571 where Lord Sterndale MR said (page 577) :-

"I think, therefore, that it is still the law that a contract can be severed if the severed parts are independent of one another and can be severed without the severance affecting the meaning of the part remaining."

20. The judgment of Younger LJ put it somewhat differently (page 593):-

"the doctrine of severance has not, I think, gone further than to make it permissible in a case where the covenant is not really a single covenant but is in effect a combination of several distinct covenants. In that case and where covenants can be carried out without the addition or alteration of a word, it is permissible. But in that case only".

21. The Court of Appeal in T Lucas and Co v Mitchell [1974] 1 Ch 129 at page 137 also fastened on the need for severance to be effective is only possible if the excision of the unenforceable part can be made without other addition or modification.
22. In a number of more recent first instance decisions, a threefold test has been developed. In the employment context, its origin is to be found in Sadler v  Imperial Life Assurance Company of Canada Ltd [1988] IRLR 388. Mr P J Crawford QC, sitting as a Deputy Judge of the High Court said (at paragraph 19):-

"In my judgment, the combined effect of those authorities is that a contract which contains an unenforceable provision nevertheless remains effective after the removal or severance of that provision if the following conditions are satisfied:

(1) the unenforceable provision is capable of being removed without the necessity of adding to or modifying the wording of what remains;

(2) the remaining terms continue to be supported by adequate consideration;

(3) the removal of the unenforceable provision does not so change the character of the contract that it becomes 'not the sort of contract that the parties entered into at all'".

23. Kay LJ approved this categorisation in paragraph 40 of Beckett.
24. In my view there is no great change in the 3 fold categorisation. The first enforces the requirement for excision to operate and does not permit of any adding or modifying the wording of what remains. The third provision applies the requirement that the removal of the unenforceable part must not so change the character of the contract that it becomes not the sort of contract that the parties entered into at all.
25. The second requirement of consideration is satisfied as both the parties accept.
26. I have no difficulty in considering that clause 21.1.1 if it was on its own could be the subject matter of the blue pencil test as contended for by the Claimant. That the parties agree would produce an area covenant limited to the Territory which both parties accept would be valid.
27. However the definition of Restricted Area is also to be found in the competition provision in 21.1.2 and the non solicitation provision in 21.1.3.
28. As I have said above both parties accept that the non solicitation covenant is valid even in the extended form as it is to be presently found. If the blue pencil test is applied to clause 21.1.1 one then needs to consider the impact that has on clause 21.2.3. In order for the wording of the Franchise Agreements to be sensible there can only be one definition of "Restricted Area" (absent a claim for rectification or the like). The consequence of cutting down 21.2.3 and the definition of Restricted Area means that when one looks at clause 21.2.3 it is similarly cut down. However that seems to me to be a modification of that clause. The clause as it stands is valid and the consequent modification of that clause means that the extent of the non solicitation clause is similarly cut down. This is despite the fact that the extended clause is accepted as being valid and freely entered into by both parties. Thus the submission of the Claimant is that the blue pencil test can simply be applied to clause 21.1.1 there is then a consequent changed meaning given to the phrase Restricted Area in the following clauses. That means that the court has rewritten a part of the contract which is (a) accepted as valid and is thus (b) a variation of what the clause means.
29. That seems to me to be a clear infringement of requirement (1).
30. I accept the Claimant's submission that the 3 limbs set out in Beckett are dealt with as follows. First the unenforceable provision needs to be removed without the necessity of adding or modifying the wording of what remains. Second there is a need for consideration but that is irrelevant in this case. Third one then looks at the overall impact on the contract as a whole to determine whether or not removal does not change the contract so it becomes not the sort of contract the parties entered into at all.
31. The fundamental difficulty facing the Claimant is that the Territory definition applies to all the covenants even those which are accepted as enforceable. It follows that if one applies the blue pencil test and excises the offending parts in the area covenant that necessarily has an impact on the other covenants. As they incorporate the definition of Territory from the area covenant the wording of the other covenants is necessarily reduced to a similar extent.
32. The effect of that therefore is necessarily to cut down a provision which the parties fully agreed and which is valid.
33. By transposing the same definition therefore into the valid covenants it seems to me clear that the proposed excision will fail to satisfy limb 1 because it is modifying the wording of what remains by implication.
34. It also seems to me to fall foul of the clearly established principle that when the court is asked to apply the blue pencil test it will not make a new contract for the parties (Chitty ibid paragraph 16-196 above).
35. Further in my view that proposed amendment would mean that the contract is radically different because the area is cut down. It is however not necessary to come to that conclusion because in my view the proposed excision falls foul of limb 1.
36. Mr Evans-Tovey accepted that had the definitions been set out in full in each of the covenants it would have been easy enough for the area covenant to be subject to the blue pencil test. That would not impinge on the other covenants.
37. Mr De la Piquerie for the Claimant in response to that submitted that the use of the word "Territory" in the other clauses is merely a shorthand for writing them out. That may be so but it seems to me that it will be necessary to vary those provisions. If one applies the blue pencil test to the area covenant the word Territory has the cut down definition in that covenant. The other covenants use the word Territory and therefore they too are similarly cut down. It is impossible without adding words to the other covenants in my view to give those covenants the accepted validity i.e. the current definition of Territory. I accept that that is artificial but that is the consequence of the draftsman linking the areas in the three covenants to a definition in the area covenant and also the limited power that the courts have to apply the blue pencil test. It is a very limited jurisdiction and absent a claim for rectification or the like it should not be used as the authorities say if either of the 3 limbs are not satisfied or as an attempt to rewrite a contract. As there is nothing wrong with the non solicitation covenants it would be quite wrong to vary them. Yet that is what the Claimant in effect contends for.
38. I considered clause 33 but it does not seem to me to do anything other than repeat the common law principles of the blue pencil test.
39. Therefore I determine the question with the answer "no".