Scottish Court of Session Decisions

OUTER HOUSE, COURT OF SESSION [2009] CSOH 53
A94/09 A93/09	OPINION OF LORD WOOLMAN in the cause CYRUS ENERGY LIMITED Pursuer; against ALAN STEWART Defender: and XYREX LIMITED Pursuer; against PATRICK McTURK Defender; ­­­­­­­­­­­­­­­­­________________

Pursuers: Summers Q.C.; Morisons

Defenders: MacNeill Q.C.; Biggart Baillie

7 April 2009

[1] Cyrus Energy Limited ("Cyrus") and Xyrex Limited ("Xyrex") are sister companies. They have the same parent company and operate from the same premises. On 17 October 2006, Mr Stewart was employed as the managing director of Cyrus. On the same day, Mr McTurk was employed in a similar capacity with Xyrex. Both men entered into a Service Agreement with their respective companies. The contracts were in almost identical terms and included a restrictive covenant. Upon the termination of their employment, the defenders agreed: (a) to a non-solicitation restraint, (b) to a non-trading restraint and (c) to a world-wide restraint against working in competition with the business of their respective employers.

[2] On 3 November 2008, Mr Stewart tendered his resignation from Cyrus. Mr McTurk tendered his resignation from Xyrex the following day. On 13 February 2009, Cyrus was granted an interim interdict against Mr Stewart. Xyrex obtained a similar order against Mr McTurk on the same day. Both orders were granted without appearance on the part of the defenders. The interlocutors reflected the terms of the restrictive covenant.

[3] The matter came before me on a motion for recall. The hearing took place over three days. Although it was a motion before calling, defences were lodged in each action. In addition, the pursuers lodged three substantial volumes of productions and an affidavit from Mr Thomas Nolan. He is the managing director of the NCS group of companies and the controlling mind behind Cyrus and Xyrex. Mr Nolan was instrumental in providing finance for the two companies from 2006 onwards.

[4] The main thrust of the submissions made on behalf of the defenders was that the worldwide restraint went too far. It went beyond what was required to protect the legitimate interests of the pursuers. It was also submitted that the balance of convenience favoured the defenders. Counsel for the pursuers contended that the covenants were valid and should be upheld.

The Background

[5] Cyrus develops, markets and supplies "fuel conditioning" products. The products are designed to assist engines operating on fuel oil to improve performance. They also prevent the growth of bacteria in engines and fuel storage tanks. Mr Stewart set up the business, using technical know-how gained from a third party. It was not incorporated until October 2006.

[6] Xyrex develops, markets and supplies products for the fishing industry. Some of its products prolong the shelf life of fish and shellfish, by inhibiting the growth of harmful bacteria. Others are used to clean equipment where fish and shellfish are stored or processed. Prior to October 2006, it was incorporated with two shareholders, Mr McTurk and Mr Ruary McGregor. Each had an equal shareholding. It appears that it was Mr McGregor who brought the defenders into contact with Mr Nolan.

[7] The common feature of the companies is that they each possess a formula for their products, which they arrange to be manufactured under rules of strict secrecy. I was told that the unique selling point of the Cyrus range of products is that they are non-detergent based, unlike those supplied by its competitors. Xyrex's unique selling point is that their products do not leave a residue.

Factual Disputes

[8] Each party invited me to base my decision on the factual matrix. However, there were a number of factual matters which were disputed.

[9] Financial position as at October 2006. Counsel for the pursuers suggested that both Cyrus and Xyrex were in difficulty and that Mr Nolan was in effect a "white knight" who had rescued the businesses. Counsel stated that Mr Nolan and the companies he controls have invested about £500,000 in the two companies to date. Counsel for the defenders disputed these matters. He stated that both businesses were financially viable and "up and running" in October 2006. With regard to the alleged injections of capital since then, the defenders' position is that they had not seen such sums and queried where the money had gone. Counsel stated that it was because of the perceived lack of financial transparency that the defenders had tendered their resignations.

[10] Future Prospects. According to the pursuers, the companies are now showing signs of financial improvement. A new Managing Director, Mr Davies, was appointed on 10 November 2008. He is an expert on sales and marketing. Since his appointment, he has travelled the world to support the products. He has also recruited a scientist, Dr Srivastaba, to assist with obtaining regulatory approval. The companies have established commercial links with various institutions, including the Glasgow University langoustine laboratory and the Strathclyde University biochemical laboratory. According to the defenders, however, the companies do not have good prospects of success. Counsel stated that Mr Davies could not have any technical discussions with customers or prospective customers.

[11] Worldwide Business. According to the pursuers, each company has a worldwide business. The defenders travelled the world to visit trade fairs and make contact with potential distributors for the pursuers' products. By contrast, the defenders claimed that the two companies only dealt with a few countries in the world.

[12] Breach of Covenant. The pursuers claimed that they had required to employ a computer expert to recover the files on the defenders' laptops. Their position was the defender had each deleted data, contrary to clause 16.1(a) of the Service Agreement. The recovered data disclosed a full list of contacts and the extent of the business. Mr Nolan states that since their resignations "I have discovered they have been approaching our customers with a view to trading with them by way of supplying products identical to those we supply". The defenders denied that they had deleted material from the laptops and stated that all data should in any event have been backed up on the server. They also denied acting in breach of the covenant.

[13] Defenders' Intentions. Within the productions is an email dated 17 November 2008 from Mr McTurk to a company called Greenfresh Innovation. The pursuers relied on that email as demonstrating the defenders' true business intentions. It stated:

"Dear Rudy

Great to speak with you today. As discussed, the other investors have agreed to put up the funds and we would be looking to have a decision from you within the next week in principle if you wish to invest the other 50000 gbp to complete the package. There are other parties who wish to invest, but I feel your company would bring much more and benefit from this investment.

Regarding the so called Press Release, we have resigned as we do not want to work for Tom Nolan or anyone else. His letter is completely inaccurate. We left because we do not want to make someone rich while we receive no benefit with the products that we and not him developed. I hope this explains our position."

Counsel for the pursuers submitted that it was wholly inappropriate to put that email before the Court. He said that Mr McTurk had written it in circumstances immediately after the termination of employment, where it was perfectly understandable that he would not wish to wash his dirty linen in public. It should be regarded as an email written at a particular time to a particular addressee against a particular background, where a particular register of voice had been used.

[14] Termination of Employment. The pursuers aver that the defenders resigned their posts. The defences state that a dispute has arisen in regard to the circumstances surrounding the termination of the respective contracts. Each defender has presented a claim for wrongful dismissal to the Employment Tribunal.

The Restrictive Covenant

[15] The relevant clause in the Service Agreement reads:

"17.2 Restrictive covenants

The Executive confirms that, neither during the Employment nor during the Restricted Period, without the prior written consent of the Company, whether by himself, through his employees or agents or otherwise and whether on his own behalf or on behalf of any person, directly or indirectly, he will not:-

(a) so as to compete with the Company solicit business from or canvass any Customer or Prospective Customer in respect of Restricted Goods or Restricted Services;

(b) so as to compete with the Company accept orders from, act for or have any business dealings with, any Customer or Prospective Customer in respect of Restricted Goods or Restricted Services;

(c) so as to compete with the Company within the Restricted Area, be employed or engaged or at all interested in a person which is involved in the business of researching into, developing, manufacturing, distributing, selling, supplying or otherwise dealing with Restricted Goods or Restricted Services, if the business is or seeks to be in direct competition with the Company. For the purposes of this sub-clause, acts done by the Executive outside the Restricted Area shall nonetheless be deemed to be done within the Restricted Area where their primary purpose is to distribute, sell, supply or otherwise deal with Restricted Goods or Restricted Services in the Restricted Area; ..."

[16] The material terms are defined as follows:

"'Prospective Customer' means any person with which the Company had discussions during the Relevant Period regarding the possible distribution, sale or supply of Restricted Goods or Restricted Services and with which during such period the Executive, or any employee who was under the direct or indirect supervision of the Executive, had personal dealings in the course of employment by the Company; 'Relevant Period' means the period of two years immediately preceding the Termination Date;

'Restricted Area' means the World;

'Restricted Goods' means any products, equipment or machinery or software or hardware researched into, developed, manufactured, distributed or sold by the Company and with which the duties of the Executive were materially concerned or for which he was responsible during the Relevant Period, or any products, equipment or machinery of the same type or materially similar to those products, equipment or machinery/software or hardware;

'Restricted Period' means the period of 12 months commencing on the Termination Date;

'Restricted Services' means any services (including but not limited to technical and product support, technical advice and customer services) supplied by the Company and with which the duties of the Executive were) materially concerned or for which he was responsible during the Relevant Period, or any services of the same type or materially similar to those services; and"

[17] The parties also agreed that if parts of the covenant were held invalid, that would not render the whole clause invalid:

"The restrictions in this Clause 17 (on which the Executive has had the opportunity to take independent advice, as the Executive hereby acknowledges) are separate and severable restrictions and are considered by the parties to be reasonable in all the circumstances. It is agreed that if any such restrictions, by themselves, or taken together, shall be adjudged to go beyond what is reasonable in all the circumstances for the protection of the legitimate interests of the Company but would be adjudged reasonable if some part of it were deleted, the relevant restriction or restrictions shall apply with such deletion(s) as may be necessary to make it or them valid and enforceable."

Shareholders Agreement & Assignation

[18] On the same day that the defenders signed the Service Agreement, they each also signed two other documents. The documents signed by each man were again in virtually identical terms. According to their counsel, they did not obtain the benefit of legal advice before executing any of these documents. In terms of the Shareholders Agreement, each defender was allocated a twenty five percent shareholding and became directors of their respective companies. The other seventy five per cent shareholding in each company was held by Xytium Technology Group Limited ("Xytium"). The shares in Xytium were held as follows: Mr Nolan (45%), Mr McGregor (45%), Mr Stewart (5%) and Mr McTurk (5%).

[19] The defenders also assigned all their intellectual property rights in the respective company's products in favour of Xytium. The definition of "intellectual property" contained in the Assignation was extremely wide and included know-how. In 2008 Xytium went into administration. Its assets were acquired by a company under the control of Mr Nolan, which is now known as EHF Technology Limited.

The Proper Approach
[20] It was suggested that two considerations should inform my approach. First, the identification of the correct test to apply. Secondly, the classification of the parties' business relationship.

[21] During the course of the hearing, it was ascertained from the Keeper of the Rolls that a proof diet in this case could not be allocated until early 2010. By then, the covenants will have expired. Counsel for the defenders referred to a passage in Lansing Linde Limited v Kerr [1991] 1 WLR 251, where Staughton LJ stated:

"So if an injunction had been granted by the judge, or is now granted, the likely effect would be to decide the dispute against the defendant for good and all. In those circumstances justice requires, in my opinion, some assessment of the merits and more than merely a serious issue to be tried."

[22] Lansing has been followed in one Scottish case, although on a different point (TSB Bank Plc v Connal 1997 SLT 1254). Counsel for the pursuers did not make any contrary submission. Given that the decision at the interim stage was likely to determine the cause, I took the view that it was appropriate to adopt the Lansing test. I therefore tried to assess the merits of parties' respective positions, allowing, where appropriate, for the disputes I have narrated. It appeared to me that one consequence of that approach is to reduce the importance of the test of balance of convenience. That is because at the stage of final interdict, such an issue does not arise.

The Nature of the Relationship
[23] Parties were divided as to the nature of the contractual relationship between the parties. Counsel for the defenders invited me to treat it as a contract of employment and therefore to subject the covenant to close scrutiny. He pointed out that the salaries specified in the contract were not particularly high. Mr Stewart was to receive an income of not less than £24,000 per year. In the case of Mr McTurk, it was to be not less than £30,000 per year. With regard to the Shareholders Agreement, counsel stressed that the defenders did not receive any monetary payment for the shares they ceded. Further, he submitted that their respective shareholdings were effectively worthless, because Mr Nolan ultimately had control over both companies, including the right (through the parent company) to buy back the defenders' shares. So this was not a case where the covenantor obtained a considerable financial benefit. Turning to the Assignation, it transferred all the intellectual property to Xytium. However, neither defender obtained any benefit from his five per cent share in Xytium, because Mr Nolan had put that company into liquidation.

[24] Counsel for the pursuers submitted that Mr Nolan had provided an injection of capital in return for the whole package of agreements signed in October 2006, including the share transfer. Accordingly, the court should view the transaction as a business acquisition. That would result in a more liberal approach being taken to the question of the reasonableness of the covenants. To do otherwise would result in unfairness. The defenders should not be entitled to seek to dilute the value of the acquisition by entering into competition (Nordenfelt v Maxim Nordenfelt Guns & Ammunition Company [1894] AC 535; Dawnay Day & Company v D'Alphen [1998] ICR 1068; and Systems Reliability v Smith [1990] IRLR 377). Mr Nolan claimed that Xytium had been put into liquidation with the agreement of the defenders.

[25] In my view, the authorities demonstrate that it is "wrong and unnecessary" to classify relationships in too rigid a fashion (Dawnay at 1106D-F). The question must always be to consider the facts and circumstances of the individual case. Here, in my opinion, the transaction was closer to that end of the spectrum occupied by the sale of a business. Very few employees have a twenty five percent shareholding in the business by which they are employed, as well as holding a directorship and rights in the parent company. It seemed to me to be inapt to bracket the defenders with normal employees. There must have been good commercial reasons for them to decide to enter into the October 2006 transactions. According to their counsel, both businesses were viable at that stage. The defenders therefore had the opportunity to negotiate the terms of the contract. If they had not wished to place themselves under the obligations of the covenant, they should not have entered into the transaction. By doing so, I was inclined to give primacy to freedom of contract over freedom of trade.

[26] However, I also took the view that the critical issues were (a) to identify the legitimate interests which the covenantee is trying to protect; and (b) to determine whether the restrictions sought went no further than was reasonably necessary (Office Angels Ltd v Rainer-Thomas [1991] IRLR 214, 219 per Sir Christopher Slade).

Restrictions (a) and (b)
[27] In respect of the first and second restraints, the dispute was in narrow compass. Counsel for the defenders accepted that there was a prima facie case, subject to one qualification. The qualification was that the definition of "prospective customers" was too uncertain and therefore unenforceable. Counsel queried what would constitute "discussion". Would it cover a telephone enquiry that was not followed up? Would it cover a leaflet handed over at a sales convention? In short, the defenders were not told with sufficient precision what they could and could not do. Counsel did not made a separate submission about the Lansing Linde test, nor did he press a strenuous argument with regard to the balance of convenience. He simply said that I should consider which decision would cause the least damage.

[28] In my view, the pursuers would succeed at proof in respect of the nonsolicitation and non-dealing restraint. They plainly have a legitimate interest to prevent approaches from the defenders to customers and potential customers. The definition of "prospective customers" gives a clear indication of the class of persons in question. There does not appear to me to be any real difficulty in identifying those with whom the defenders had personal dealings in the course of their employment. I note that a similar clause was enforced in International Consulting Services UK Limited v Hart [2001] IRLR 227. Given the strength of the case, it is my view that the balance of convenience tips decisively in favour of the pursuers. Accordingly, subject to what I say below about the form of the order, I am satisfied that the interim interdicts should be continued in respect of restraints (a) and (b).

Restriction (c) The Worldwide Covenant
[29] Counsel for the defenders argued that the onus was firmly on the pursuers to justify the restriction (Office Angels Ltd para. 21). He maintained that they were adequately protected by restraints (a) and (b). Accordingly, it was unnecessary also to grant them protection in terms of restraint (c). He submitted that it plainly went further than was required (Malden Timber v McLeish 1991 SLT 727, 730-731). He submitted that a worldwide restraint would prevent the defenders from being employed or engaged in a similar capacity anywhere in the world. Counsel drew a distinction between marketing and having a market. He argued that it was not enough for the pursuers merely to aver a worldwide market. They had to demonstrate that they actually operated throughout the world. All that the pursuers offered to prove was that they sold their products to a limited range of countries. He distinguished the present case from Nordenfelt, as that had been sold for a very large sum of money. It could also be distinguished from Bluebell Apparel v Dickinson 1980 SLT 157. There the employee had a very detailed knowledge of Wranglers' business, which would be advantageous to their rivals Levi Strauss anywhere in the world.

[30] Counsel for the pursuers submitted that the reasonableness of the covenant fell to be assessed at the time that it was made and not in the light of subsequent developments. He described Cyrus and Xyrex as "nascent businesses" in October 2006. They had few actual customers. However, given the specialised nature of their products, it was expected that prospective customers would appear all over the world. In other words, there was a potential market with a global reach. Counsel stressed that the parties were business people with a relative equality of bargaining power. They were therefore the best judges of the reasonableness of the covenant (Dawnay at 1107 per Evans LJ). In any event, the period of the restriction was only twelve months. Further, the defenders had expressly agreed that the restrictive covenant was reasonable and had also acknowledged that they had had an opportunity to seek legal advice on its terms. In those circumstances, the contract should be given effect.

[31] I agree with Mr MacNeill that the onus is on the pursuers to demonstrate that a worldwide restraint is justified on the facts and circumstances of the present case (Nordenfelt; Littlewoods; Bluebell Apparel; and Dawnay). It cannot be used as a means to simply stifle competition. The pursuers' legitimate interests in this case are (i) their trade secrets and know-how; and (ii) their business connection. So the question is: What is reasonably necessary for their protection? Are they adequately protected by restrictions (a) and (b) of the covenant?

[32] Restraints of the type contained in branches (a) and (b) are notoriously difficult to police. Sometimes "the only practicable solution is to take a covenant from the servant by which he is not to go to work for a rival in trade" (Littlewoods v Harris [1978] 1 All ER 1026, 1033 per Lord Denning). It is also more common to grant a covenant where specialist products are involved (Beckett Investment Management Group Ltd v Hall [2007] ICR 1539, paras 25 to 26). At the time of contracting, no doubt the parties hoped that each business would achieve a worldwide market. Given the nature of the products, it was expected that sales would take place anywhere around the globe. However, it was also likely that it would take time, effort and resources to establish public confidence in the products. This was particularly important in relation to those supplied by Xyrex, as their range of products would enter the food chain.

[33] It was also expected (and proved to be the case) that the defenders as individuals would be inextricably bound up with the success of the companies. Each was the public "face" of their company. Each had the technical know-how lying at the heart of the business. If either left, it could place a large dent in the chances of success. If they went into competition, they would be serious rivals to the pursuers. It would be likely to have a significant and adverse effect on the pursuers' goodwill. It is instructive to consider what would have happened if the businesses had been successful. Then the defenders stood to participate in the financial rewards through their shareholdings.

[34] I have considered the effect of the Assignations of intellectual property rights granted by the defenders. In my view they do not provide protection to the pursuers. That is because, as I understand matters, neither pursuers' products are the subject of patents. Accordingly, it might prove extremely difficult to prove whether a particular formula was or was not included in the transfer or rights. In any event, the pursuers are not the assignees and are not the beneficial holder of the assigned rights.

[35] Turning to the balance of convenience, counsel for the defenders submitted that it tipped in their favour. He pointed to the limited range of countries in which the pursuers had actually established a market. In relation to the fish products supplied by Xyrex, he said they had not received EU approval and were therefore banned in the EU and countries which export to the EU, such as Indonesia. By contrast, the crustacea products have been approved for use in the EU. He stated that the interim interdict has had a marked effect on the personal circumstances of the defenders. Neither is in a position to obtain a job in the field in which they are qualified. Mr McTurk has been refused benefit because there still a doubt as to whether or not he voluntarily left his last job. He has had to put his house on the market. Counsel for the defenders emphasised at the bar that neither of them has, nor intends, to deal with the pursuers' products or services, or copies of them.

[36] There was an overlap between the arguments directed at the merits and those relating to balance of convenience. As indicated above, that may flow from an application of the Lansing Linde test. In this case, I conclude that the pursuers would succeed at proof in establishing that restraint (c) is reasonably necessary for their protection. I reach that conclusion on the basis that the pursuers are entitled to a reasonable period in which to secure their legitimate interests. It is also my view that the balance of convenience favours the pursuers. I am not persuaded that the post­covenant factors upon which the defenders relies should prevent the order being continued. In my view, the crucial considerations are: (i) that the covenant was made in circumstances closer to the sale of a business than to an employment contract; (ii) that it is only to last one year; and (iii) that it would be difficult if not impossible for the pursuers to quantify their loss in the event that the interim order was recalled, but they were ultimately held to be correct.

Terms of the Interlocutor

[37] It follows that I shall not grant the motion to recall the interim interdicts. Certain matters arose during the course of the hearing, however, which require the current orders to be amended.

[38] First, the conclusions omit the words "so as to compete with the company". In my view, the current interlocutors must be amended to faithfully reflect the terms of the covenant. Counsel also submitted that they omitted reference to the "Restricted Period" of twelve months. However, as each interlocutor contains a date upon which the order expires, I think this is unnecessary.

[39] Secondly, during the course of the hearing, counsel for the pursuers passed up a list of customers and prospective customers. He said that they had been recovered from the respective laptops of each defender. He suggested that the interim interdict could expressly incorporate that list by reference to give further precision relating to restraints (a) and (b). In reply, counsel for the defenders stated that the list included a number of persons who clearly were not prospective customers. He also submitted it was preferable not to have a list, because the pursuers would be unable to prove that the vast majority of persons named on the list were prospective customers. In light of the defenders' view, I am not prepared to incorporate such a list in the interlocutor. At this stage and without definite information about the status of those appearing on the list, it appeared to me to be going too far to incorporate their names in any court order.

[40] Thirdly, Mr Summers proposed three alterations to the wording of the covenant itself:

(a) In respect of the definition of "Restricted Goods" to delete from "or any products" to the end.

(b) In respect of the definition of "Restricted Services" to delete from "or any services" to the end.

(c) In respect of the branch (c) of the covenant, to delete from "for the purposes of the sub clause" to the end.

Mr MacNeill did not oppose these suggested alterations and I propose simply to record them in the Minute of Proceedings.