Telfer Electrical Nelson Limited v Trotter
[2017] NZHC 3155
•15 December 2017
IN THE HIGH COURT OF NEW ZEALAND NELSON REGISTRY
I TE KŌTI MATUA O AOTEAROA WHAKATŪ ROHE
CIV-2017-442-33
[2017] NZHC 3155
BETWEEN TELFER ELECTRICAL NELSON LIMITED
PlaintiffAND
KENNETH JOHN TROTTER
First Defendant
DUNCAN COTTERILL NELSON TRUSTEE (2010) LIMITED, GAIL ELIZABETH TROTTER AND
KENNETH JOHN TROTTER as trustees of the K & G TRUST
Second Defendants
Hearing: 12 December 2017 Counsel:
C T Gudsell QC and G A Cooper for plaintiff J C Ironside and N A Ironside for defendants
Judgment:
15 December 2017
JUDGMENT OF CHURCHMAN J
Introduction
[1] By notice of interlocutory application dated 30 May 2017, the plaintiff, Telfer Electrical Nelson Limited (TENL) applied for an interim injunction restraining the first defendant Mr Trotter (KT) from being employed by NZ Electrical Solutions Limited (NZESL).
TELFER ELECTRICAL NELSON LIMITED v KENNETH JOHN TROTTER [2017] NZHC 3155 [15
December 2017]
[2] The application also sought an interim injunction restraining KT from being involved in any capacity in any other business in the greater Nelson area that is the same or similar to the business of TENL for 12 months from the date of the granting of the order, or alternatively from 14 February 2017.
[3] Simultaneously with the application for an interim injunction, the plaintiff filed a statement of claim. The relevant provisions of that document sought a declaration that the restraint of trade provision in cl 21 of a Shareholders Agreement between the plaintiff and the second defendant dated 27 May 2011 (the SA) is valid and enforceable on its existing terms.
[4] The statement of claim also sought injunctions. However, the injunctions did not specifically refer to a start point for the period of the restraint from 14 February 2017, but instead sought:
… a period of twelve (12) months from the date of the order or such other period determined by the Court.
[5] Neither the interim injunction application nor the substantive statement of claim specifically sought any relief under s 8 of the Illegal Contracts Act 1970 (this legislation has since been replaced by s 83 of the Contract and Commercial Law Act 2017, which came into effect on 1 September 2017).
[6] In addition to the cause of action in the statement of claim relating to the restraint of trade clause, the statement of claim contained three other causes of action.
[7] The defendants protested the jurisdiction of this Court to entertain the proceedings set out in the statement of claim. This was on the basis that TENL and KT had attended mediation before a Ministry of Business, Innovation and Employment (MBIE) mediator and had settled a number of employment relationship issues, and other issues which, although connected with the employment, did not fall squarely within the definition of employment relationship problems.
[8] On 17 October 2017, Dobson J issued a reserved judgment in relation to the protest to jurisdiction matter.1 He held that the first, third and fourth causes of action in the statement of claim did not constitute employment related problems and were therefore outside the jurisdiction of the Employment Relations Authority (ERA). He held that in respect of these matters, the status afforded by s 149 of the Employment Relations Act 2000 did not apply.2
[9] By notice of appeal dated 24 October 2017, the defendants have appealed the decision of Dobson J to the Court of Appeal.
[10] The defendants applied for a stay of the current interim injunction and the High Court proceedings pending resolution of the appeal to the Court of Appeal. By judgment of 7 November 2017, Dobson J refused to grant a stay.
Facts
[11] TENL was incorporated in 2007 by Ross Gordon (RG). Initially, another of RG’s companies, Telfer Electrical Holdings Limited, was the sole shareholder.
[12] In 2011, a family trust associated with KT acquired a 25 per cent shareholding (75,000 shares at $1 each) as did a trust associated with Jason Collett (JC). Both KT and JC became directors. RG remained a director and Telfer Electrical Holdings Limited retained a 50 per cent shareholding.
[13] TENL is part of the Telfer Group and is an electrical wholesale business. The original company in the Telfer Group, Telfer Electrical Limited, was founded in 1951 and currently has seven trading entities based throughout the South Island. According to the valuation of TENL undertaken by Richard McKnight of Price WaterhouseCoopers (PwC) in February 2017:3
The trading entities are wholesalers supplying electrical trade-based customers in Invercargill, Dunedin, Cromwell, Christchurch, Nelson, Hornby, Papanui and Timaru.
1 Telfer Electrical Nelson Ltd v Trotter [2017] NZHC 2528.
2 At [59].
3 Injunction Bundle of Documents [IBD], vol 1 at 229.
[14] The PwC valuation describes TENL as operating “… an electrical wholesale business based in Nelson …”. The valuation also notes that TENL, through the Telfer Group, is part of an entity called “Powerbase” which is a buying group whose membership is open only to electrical wholesalers.
[15] The description of the business of TENL is consistent with the description given of the business of Telfer Electrical Limited on its website.4 The Telfer Electrical Limited website also refers to the group providing “specialised services such as lighting designs for large complexes”.
[16] The Telfer Group did not have a Nelson-based business until TENL commenced operation. TENL did not commence operation immediately upon incorporation of the company but appears to have started trading on or about 1 October 2009. KT and JC were foundation employees.
KT’s employment with TENL
[17] KT had a background working for another Nelson-based electrical wholesale business, having started in that capacity in 2001 as a storeman and eventually becoming manager of the branch. It was whilst working in that business that KT had met JC. It was JC who offered him the opportunity of working for TENL once it was set up.
[18]KT’s initial salary with TENL was $75,000 per annum, which he said was a
$10,000 cut from his prior salary. During the course of his employment with TENL, KT had three salary increases:
·on 29 August 2012 to $80,000;
·on 20 November 2013 to $85,000; and
·on 6 May 2015 to $95,000.
4 IBD vol 2 at 419.
[19] It appears that KT was not provided with a written employment agreement at the time of the commencement of his employment at TENL.
[20] During his period of employment at TENL, KT undertook the sorts of tasks typical of an employee of an electrical wholesaling business. This included ordering stock, charging and invoicing, stocktake preparation, serving customers and answering the phone.5
[21] KT did not, during his employment, have any personal involvement in the lighting design work apparently undertaken principally by Telfer Electrical Ltd in Christchurch.
KT’s directorship and shareholding at TENL
[22] In about February 2011 RG approached KT and JC about becoming directors and shareholders in TENL.
[23] The establishment of local trading companies as members of the Telfer Group where those companies are 50 per cent owned by RG or a company he controlled and 50 per cent owned by local employees is a common feature of the companies in the Telfer Group. Apparently standard documentation is used.
[24] On 15 April 2011 Telfer Group’s solicitors, Anderson Lloyd, sent Duncan Cotterill in Nelson some documents in relation to the proposed acquisition by KT and JC of shares in TENL. These included an agreement for sale and purchase of shares, a shareholder’s agreement and a special purpose trust deed. Documentation in relation to a term loan and overdraft agreement, a deed of guarantee, and board and shareholder resolutions were also sent. Duncan Cotterill provided advice to KT on these documents. The SA contained a restraint of trade provision lasting 12 months from the day a party ceased to be a party to the SA.
[25] There is some dispute as to whether or not a Management Employment Agreement (MEA) was also provided to KT. The letter from Anderson Lloyd to
5 Affidavit of Kenneth John Trotter, 15 November 2017 at [15] to [18].
Duncan Cotterill dated 15 April 2011 does not refer to such an agreement as being included with that letter. The emailed letter of advice from Duncan Cotterill to KT of 11 February 2011 does not mention it either and neither does the invoice from Duncan Cotterill to KT of 20 June 2011 include any account for advising on it. KT says that he never received it.
[26] An unsigned version of the MEA stamped “draft” was produced for this hearing6 but there was not admissible evidence that this was ever executed by KT or received by him.7
[27] The MEA also contained a restraint of trade provision. It was different to the restraint of trade provision in the SA. At cl 19.2 the MEA set out a restraint for a period of six months after the termination of the agreement in relation to non- competition, as well as non-solicitation of clients, suppliers of services and of employees or contractors to TENL.
[28] As part of the acquisition of shares in TENL KT and JC were required to provide a personal guarantee in respect of TENL’s obligations to the ANZ Bank. These obligations were a loan of $300,000 and a business overdraft of $150,000. The guarantees were proportionate to this respective shareholding.
[29] On 18 April 2011 Teresa Gargiulo of Duncan Cotterill’s Nelson office wrote to KT and JC in relation to the proposed guarantee. The letter, appropriately, made it clear that Duncan Cotterill were only acting in a limited way for KT and JC. The letter included the comments:8
We are acting as your solicitors in this matter but only to the limited extent of explaining the guarantee to you and witnessing your signature.
[30]The letter also specifically said:9
6 IBD at 151.
7 The affidavit of Ross Kenneth Gordon, dated 22 November 2017 appends as RG1 an unsigned letter from Duncan Cotterill (Paul Calder to “Mr KJ Trotter” and “Mr JB Collett”) dated 4 February 2010 which purports to enclose a number of documents including an “Employment Agreement”. There is no evidence this was ever sent to KT. It is dated some months earlier than the transaction actually occurred.
8 IBD at 316.
9 At 316.
… you must realise that we cannot look at whether the transaction is a wise one for you, and if you think you may need advice about that, you must tell us and we cannot act for you at all.
[31] As well as acting for RG and TEHL, Duncan Cotterill also acted for TENL. Exhibit RG4 to RG’s affidavit of 22 November 2017, which is an application for credit by TENL dated 21 October 2009, lists Duncan Cotterill as TENL’s solicitors.
[32] Duncan Cotterill continued to act as TENL’s lawyers throughout the period of KT’s employment there and annexed to the affidavit of RG of 22 November 2017 as exhibit RG10 is a letter from Dean Palmer of Duncan Cotterill dated 5 December 2016 confirming that Duncan Cotterill was representing TENL in relation to the employment relationship problem between KT and TENL.
End of employment relationship and new role at NZESL
[33] By the end of 2016 the employment relationship between KT and TENL had soured and KT had raised an employment relationship problem. The parties entered into mediation.
[34] KT’s employment with TENL ceased on the 14 February 2017 which was the day the settlement mediated by the MBIE mediator was entered into.
[35] KT was initially unemployed after his employment at TENL ceased but was able to obtain employment with NZ Electrical Solutions Ltd (NZESL). NZESL is an electrical contracting company carrying on the business of providing electrical engineering design of electrical systems, their installation and the commissioning and maintenance of those electrical systems. It employs some 33 registered electricians plus about 10 administrative staff and apprentices. It operates in the Nelson, Blenheim and Christchurch regions. Its principal is Rory Comer (RC), an electrical engineer, who KT knew as a result of RC’s friendship with his son.
[36] KT commenced work with NZESL on 13 March 2017 with the terms of his employment set out in a written employment agreement dated 13 March 2017.10 His
10 IBD at 346.
remuneration was by way of an hourly rate specified as being $30. For a 40-hour week this would have been the equivalent of an annual salary of $62,400. In his affidavit of 15 December 2017 KT deposed that this was about a 30 per cent drop from the income he enjoyed at TENL as at the date of the cessation of his employment there.
[37] The employment agreement position description described KT’s role as that of “labourer”. The nature of KT’s work at NZESL was expanded on in the affidavits filed on behalf of the defendants and it seems that the role involves administrative work including work that might normally be undertaken by a PA.11 There was no evidence that his role at NZESL had any managerial component.
NZESL as customer of TENL
[38] NZESL was, both prior to KT’s employment with them and subsequently, a customer of TENL.
[39] There is some debate as to whether the amount NZESL spent at TENL has trended down since KT commenced employment with them. Details of its spending between November 2015 and October 2017 were appended as exhibit R to the affidavit of RC dated 14 November 2017. Mr Gudsell QC, counsel for the plaintiff, accepted at the hearing that these figures were accurate. At the hearing, Mr Gusdell sought to file an affidavit from RG analysing the spend figures and relying on information from an entity called Creditworks to establish that the total proportion of NZESL’s wholesale purchases at TENL had dropped from approximately 90.8 per cent to 74.8 per cent. I allowed the affidavit in but with a reservation as to what, if any weight I could attach to it. I have now had the chance to review that affidavit in the context of the other evidential material that Mr Gudsell referred me to, I have concluded that any reference to work undertaken by Creditworks amounts to documentary hearsay and I place no weight on this affidavit.
[40] A significant feature of the spend detailed in exhibit R to RC’s affidavit of 14 November 2017 is its variability from month to month. In the 12-month period from November 2015 to October 2016 the total spend was $338,462.94 with an
11 Affidavit of Rory Comer, 14 November 2017 at [47].
average monthly spend of $28,205.25 and monthly variations ranging from $7,820.43 in April 2016 to $85,991.37 in the following month, May 2016.
[41] November and December of 2016 were by far the two biggest spend months in the two year period adduced in evidence with spends of $125,866.42 and
$107,791.29 respectively. In the year from November 2016 to October 2017 the total spend was $870,907.19 producing a monthly average spend of $72,575.60.
[42] If the figures for just the eight months during which KT has been employed by NZESL are considered on their own, the average monthly spend produces a total spend of $505,452.61 or an average monthly spend of $63,181.57.
[43] If the average for the 16-month period prior to March 2017 (the period when KT was working at TENL) is taken, it produces a monthly average of $43,994.84.
[44] These figures show that while the heights of November and December 2016 have not been replicated either before or since then, the average monthly spend by NZESL at TENL since KT joined NZESL has increased substantially on the prior 16 month period.
[45] At [45] of his affidavit of 14 November 2017 RC explains some of the reasons for the monthly variation in NZESL’s purchases and notes that for most of this year its major project has been a cool store at Rolleston, the electrical product for which had been purchased at the start of the job.
The law
Interim injunctions
[46] The test in relation to an application for an interim injunction is well-known. The Court of Appeal in NZ Tax Refunds v Brooks Homes Ltd said:12
The applicant must first establish that there is a serious question to be tried or, put another way, that the claim is not vexatious or frivolous. Next the balance of convenience must be considered. This requires consideration of the impact
12 NZ Tax Refunds v Brooks Homes Ltd [2013] NZCA 90 at [12].
on the parties of the granting of, and the refusal to grant, an order. Finally, an assessment of the overall justice of the position is required as a check.
[47] This test has consistently been applied in relation to interim injunction seeking to enforce a restraint of trade obligation.13
[48] In relation to the issue of balance of convenience, where damages would be an adequate remedy the balance of convenience would not normally require any interim intervention by the Court.14
[49] In addition to the question of the adequacy of damages, in determining the balance of convenience the Court will also have regard to
(a)the status quo;
(b)the relevant circumstances of the case;
(c)the relative strength of each parties case;
(d)the effect on innocent third parties; and
(e)the conduct of the litigants.15
Restraints of trade
[50] Any covenant in restraint of trade, whether it is contained within an employment agreement, a shareholder’s agreement, an agreement for sale and purchase of a business or any other contractual arrangement is void as being contrary to public policy. A party wishing to enforce such a covenant is obliged to apply to the Court. At the time this interim injunction was applied for, the relevant law was s 8 of the Illegal Contracts Act 1970.
13 See Western Work Boats Ltd v Kelly [2016] NZHC 2577 and Feng v Liu [2017] NZHC 2479.
14 See Cabco Group Ltd v Bartlett (2009) 6 NZELR 500 at [30] per Asher J and Feng v Liu [2017] NZHC 2479 at [32] per Venning J.
15 See Tyre Collection Services Ltd v Le Roy [2016] NZHC 403 at [47] per Dunningham J.
[51] The enforceability of a covenant in restraint of trade is governed by the legitimate proprietary interest that the covenant relates to and as Richardson J said in Brown v Brown:16
It is well settled law that to be enforceable a covenant in restraint of trade should be no wider than the circumstances of the case reasonably require. Reasonableness in the relevant sense relates to the legitimate interests of the parties in the covenant and to the wider public interest.
[52]Also, as noted by Richardson J in the same case:17
As with any other contractual provision, a restraint of trade covenant must be considered in the context of the whole agreement between the parties and against the background of the circumstances in which it was entered into. The first step is to consider the setting in which the agreement, of which the covenant forms part, was made.
[53] One of the principal criteria for establishing the reasonableness of a covenant in restraint of trade is what consideration was provided for it. Typically, in restraint of trade covenants found in an employment agreement, the nature and quantum of consideration is different to that found in a commercial agreement, particularly one for the sale and purchase of a business where a large sum is being paid to the covenantor by way of goodwill for the business. This was expressly acknowledged by the Court of Appeal in Fletcher Aluminium Ltd v O’Sullivan where Gault J said:18
That the Courts have approached restraint covenants entered into at the time of the sale of the goodwill of a business differently from such covenants in employment contracts is clear enough. … The difference derives from the fundamental proposition that a restraint of trade should be no wider than is required to protect the party in whose favour it is given. The purchaser of goodwill requires protection against the erosion of that goodwill. The employer requires protection against an employee taking advantage of the employer’s trade and commercial information acquired by the employee in the course of employment.
[54] In restraints of trade not included in an employment agreement, particularly those involving a purchase of a business and a substantial payment for goodwill, the Courts have also considered, in assessing reasonableness, matters such as the relative bargaining strength of the parties and whether the parties both had the benefit of independent legal advice. This was a significant factor in the enforceability of the
16 Brown v Brown [1980] 1 NZLR 484 (CA) at 491, line 45.
17 At 492, line 36.
18 Fletcher Aluminium Ltd v O’Sullivan [2001] 2 NZLR 731 at [28].
restraint of trade covenant in Fletcher Aluminium Ltd v O’Sullivan where the Court said:19
The covenant was negotiated by the parties at arm’s length and on equal terms, the negotiations were extensive and were conducted with the assistance of legal advice. It was a term in an overall commercial arrangement having a large element of sale and purchase of property intended to become the key element in (the covenantee’s) business.
[55] Irrespective of the type of document that the restraint of trade covenant appears in, it is important, for the purposes of enforceability, that the restraint focuses on the legitimate proprietary interest that requires protection. Restraints which are standard form or generic across an entire workforce without considering the work of that employee and how the restraint relates to protection of a legitimate proprietary interest are less likely to be found reasonable than restraints which are tailored to do no more than is reasonable in the particular factual context of each case.20
[56] Restraint of trade covenants take a number of different forms ranging from covenants that are purely anti-competitive and which generally seek to restrain the covenantor from having any interest in any business that could be in competition with the covenantee, through restraints that seek to restrain the covenantor from acting for or servicing a prior customer or client (non-dealing provisions), to provisions restraining the covenantor from soliciting the covenantee’s clients, customers, or employees (non-solicitation provision) to covenants seeking to only prohibit the misuse by the covenantor of confidential or proprietary information.
[57] The difference in the duration that might be held to be reasonable in relation to the varying types of covenant in restraint of trade is frequently illustrated in cases involving professional employees who may or may not have an equity interest in the covenantee’s business. Such businesses typically include lawyers, accountants, and those providing financial services. The employee in question may often be the principal or only contact between the covenantee and its clients.
19 At [45].
20 Brown v Brown, above n 16, at 491 per Richardson J.
[58] The High Court addressed this issue in the case of Spicers Portfolio Management Ltd v Cunningham Financial Services Ltd where, in distinguishing a non-dealing restraint from a non-solicitation one Dobson J said:21
It would follow that [the covenantee] could not make out the necessity for any longer period than six months, in relation to the modified non-solicitation restraint. … From [the covenantee’s] perspective, it is one thing to prevent a former adviser from accepting a request from [a covenantee’s] client to provide financial advice, and quite another to stop such an adviser taking the initiative to contact clients of [the covenantee] and persuade them to do so.
[59] Where a covenantee is seeking to enforce a grossly unreasonable restraint of trade they are likely to have difficulty convincing the Court to modify it and enforce some lesser restraint. As Dobson J said:22
However, those seeking modification of grossly unreasonable provisions may face a more difficult task, for reasons including the inference that the grossly unreasonable nature of the original restraint [suggests] a real inequality of bargaining power at the time the restraints were agreed to.23
[60] In Spicers, Dobson J found that there was not even a serious question to be tried for enforcement of anything beyond a six-month non-dealing restraint and an 18- month non-solicitation restraint.24
The restraint in question
[61]Clause 21.1 of the SA provides that:25
Restraint — The shareholders covenant that, in consideration of their entering into this agreement, no Shareholder and no Related Party of a Shareholder will, without the prior written approval of all remaining Shareholders except as provided at cl 12.12:
21.1.2 while they are a Party to this Agreement; and
21.1.2for a period of twelve (12) months after any Shareholder ceases to be a party to this Agreement;
do either of the following:
21 Spicers Portfolio Management Ltd v Cunningham Financial Services Ltd [2014] NZHC 74 at [39].
22 At [40].
23 At [40].
24 At [42].
25 IBD vol 1 at 133.
21.1.3directly or indirectly carry on or be interested, engaged, or concerned in, whether alone or in partnership with or as manager, agent, director, shareholder or employee or beneficiary under a trust or in any other capacity in any other business in the greater Nelson area that is the same as or similar to the Business; or
21.1.4directly solicit or approach and entice or endeavour to entice away any of the employees of the Company, its customers, any of its subsidiaries or any related company.
[62] Clause 21.1.3 is a non-competition clause and cl 21.1.4 is a non-solicitation clause. For the reasons set out above, the Courts are likely to find, as between the two different types of restraint, that a longer period for a non-solicitation obligation is more likely to be reasonable than the relevant non-compete period.
[63] The Shareholders Agreement is between the shareholders of TENL. KT is not a shareholder. However, his family trust, the K & T Trust is a shareholder and it is not disputed that KT was and is a “Related Party” within the meaning of cl 21.1.
[64] There is clarity around some of the key terms of the restraint obligation and ambiguity around others. The three key elements of the restraint are the interest protected, the location and the duration.
[65] Clause 21.1.3 restrains the covenantor from being employed by another business that “is the same as or similar to the Business”. The term “the Business” is defined as being the “business of the Company electrical wholesaling”.26 The critical issue is therefore whether the business of NZESL could be said to be “the same as or similar to” the business of an electrical wholesaler. I will address this at [93] of this decision.
[66] The term “the greater Nelson area” is hardly precise and is challenged by the defendants as being too imprecise but, on any interpretation of the facts, NZESL operates in Nelson City and throughout the Nelson Region, so nothing turns on the issue of precision of definition of the geographical area.
26 IBD vol 2 at 117.
Duration
[67] However, there is a significant issue arising from the wording of cl 21.1.2 which says that the covenant is to apply “for a period of twelve (12) months after any Shareholder ceases to be a party to this Agreement”.
[68] Restraint of trade covenants, whether they are an employment agreements, agreements for the sale of purchase of a business or shareholder agreements, typically commence on the day employment ceases. The reason for this is that what is sought to be restrained is the ability of the covenantor to work for another entity.
[69] The different durations of restraint that are deemed reasonable by the Courts reflect the fact that the covenantee is usually at its most vulnerable to unfair competition from the covenantor in the period immediately after the cessation of employment. The legitimate proprietary interest most commonly cited as supporting the reasonableness of a restraint is the customer connection between the covenantee and its customers or clients which the covenantee needs to shore up following the departure of the covenanator. The Courts have recognised that otherwise, in many situations, those client relationships will be vulnerable to immediate exploitation by the departing covenantor.27
[70] The fact that cl 21.1.2 stipulates that the 12 month period in the restraint does not commence until the shareholder ceases to be a party to the agreement creates real problems. Presently, the second defendant still owns shares in the plaintiff. There is no indication when the second defendant might cease to be a shareholder in the plaintiff and accordingly it is not possible to identify when the 12 month period of restraint described in cl 21.1.2 might actually commence. There is accordingly no way of knowing exactly how long, after the employment finished, this restraint might bind KT for.
[71] The parties seem to be no closer to this outcome than they were back in February. KT has no control over when the process of sale of shares might be concluded. If it takes another year then the plaintiff would be seeking to enforce a
27 See Spicers Portfolio Management Ltd v Cunningham Financial Services Ltd above n 21 at [39].
twelve-month restraint not commencing for nearly two years after the employment relationship ended.
[72] It is clear that the drafter of this clause gave no thought to the issue of exactly what legitimate proprietary interest was being sought to be protected by the restraint and did not draft the restraint so as to be the minimum period necessary for the protection of that interest.
[73] As an alternative to issuing an interim injunction in the terms as appearing in the SA, the prayer for relief sought one for 12 months’ from 14 February 2017. There was little focus in either the written or oral submissions of counsel as to how a 12 month restraint from 14 February 2017 would protect any particular proprietary interest or why that particular duration had been sought. There was no indication as to whether the 12 month period from 14 February 2017 was intended to apply to the non-solicitation component of the restraint or the non-competitive component as well.
Reasonableness
[74] For the plaintiff, Mr Gudsell said that an appropriate starting point was the fact that the second defendants acknowledged that the restraint was reasonable in 2011 upon signing the SA.28 Clause 21.3.1 provides:
the restrictive covenants contained in cl 21.1 are reasonable and necessary and have been given to protect and maintain the proprietary interests of the Company.
[75] Where, for legal reasons, a restraint is found to be unlawful in accordance with the tests for unlawfulness established by the Courts over the years, the fact that a party to an agreement may have signed an agreement which says it was reasonable is of no assistance to the Court.
[76] Further to this, nowhere does the clause specify what the “proprietary interests of the Company” are said to be. The clause certainly cannot be conclusive as, in cl
21.4 the drafter has specifically adverted to the prospect that one or more of the provisions may be held to be an invalid and unreasonable restraint and has included a
28 IBD vol 2 at 133.
severability clause. That would not have been needed if the acknowledgment of the covenantor that the terms were reasonable was conclusive evidence on that point.
Consideration
[77] Next the plaintiff argued that it is important to recognise that the restraint is contained in shareholder’s agreement and not an employment agreement. The Courts have clearly identified that the payment of large sums of money for goodwill in agreement for sale and purchase cases or the receipt of significant financial benefits in other cases, means that a Court will more readily infer that the consideration for the grant of the covenant in restraint of trade made aspects of the restraint reasonable when, in the context of an employment relationship, the absence of extensive valuable consideration might produce a different result.
[78] Typically, in employment agreements the consideration is usually described as being the offer of employment.29 Where a restraint of trade obligation is introduced during a period of employment or modified once employment has started, unless there is some further consideration, often by way of a lump sum payment or sometimes by way of a substantial increase in salary or the provision of some other form of benefit, the Court will find an absence of consideration and refuse to enforce a restraint.30
[79] The plaintiff’s submission is that “… the restraint was negotiated as part of an arm’s length commercial arrangement between a pre-existing employee and his employer”. It was claimed that the restraint was part of a “suite of documents” provided to KT and that, in return for entering into the SA, KT received the benefit of shares which have increased substantially in value beyond the purchase price.
[80] Mr Ironside, for the defendants disputed that there was consideration for the grant of the restraint. He pointed out that KT was already an employee and did not receive any increase in remuneration as a result of entering into the restraint. However, this overlooks the point that this restraint is not in an employment agreement. The
29 Fuel Espresso Ltd v Hsieh [2007] NZCA 58.
30 M A Watson Electrical Ltd v Kelling [1993] 1 ERNZ 9.
consideration did not come from any change to his employment terms and conditions, but from the opportunity to purchase the shares.
[81] The consideration for the restraint was the entry into the shareholder’s agreement, which brought with it the opportunity for KT to acquire shares which have ultimately increased in value. Just as the entry into an employment agreement can provide consideration for a restraint of trade covenant in such an agreement, so too, in a shareholder’s agreement, can the entry into that agreement amount to consideration.
[82] However, the plaintiff overstates the position by referring to the fact that the shares are now apparently worth some $230,000 and implying that their current value is relevant.31 The reasonableness of the restraint is assessed as at the date the covenant was entered into. In 2011 when the SA was signed, the plaintiff was a relatively recent start up. There was no guarantee how successful it would be. The financial accounts for the year ended 31 March 2012 (the financial year during which KT acquired the shares) and the financial year ended 31 March 2013 show that for the 2012 year TENL made a loss of $173,848 which reduced to a loss of $29,373 in 2013.32 The plaintiff’s financial performance, as would be expected with a start up company, has steadily improved. Given that as part of the share purchase equation KT also took on a proportionate (25 per cent) share of liability for the bank loan and overdraft, there was some risk attached to aspects of the transaction by which his family trust acquired the shares. He also had to borrow the full purchase price.
[83] This is certainly not a case comparable to the likes of Fletcher Aluminium Ltd v O’Sullivan where Mr O’Sullivan received payment of some $1.7 million which included a significant component for goodwill.33
[84] I conclude that the consideration KT received for his trust entering into the SA restraint of trade was the opportunity to make future profits. This consideration needs to be seen in the context that KT needed to mortgage his house to raise money for the
31 Submissions of counsel for plaintiff addressing interlocutory application by plaintiff for interim injunction, 29 November 2017 at [13](i)(iv)].
32 IBD at 336.
33 Fletcher Aluminium Ltd v O’Sullivan above n 18.
purchase price and also entered into what for him were significant financial guarantees.
Independent legal advice
[85] As I set out at [54] above, the bargaining position of the parties and the provision of independent legal advice to the covenantor in a non-employment restraint of trade goes to its reasonableness. In ascertaining whether or not KT was bargaining in an equal position of strength to RG at the time the SA agreement was entered into, it can be noted that RG had a long track record as a successful businessman who had used this type of shareholding model numerous times in relation to other businesses in the Telfer Group. By way of contrast, there is no evidence that KT had any background as a businessman on his own account. He had previously been a storeman and branch manager.
[86] Correspondence from Duncan Cotterill to RG’s lawyer indicated that both KT and JC were surprised on learning of the guarantee arrangements proposed by RG and TENL.
[87] Recent decisions such as Carpet Barn Hamilton Ltd v Jobe and AMP Services (NZ) Ltd v Visser explored whether a party entering into a restraint of trade covenant of this nature had access to independent legal advice.34 Here there is no doubt that KT had legal advice on some aspects of the transition to director/shareholder.
[88] However, in the context of whether or not KT can be said to have received independent legal advice, the far more important point is that, for the reasons detailed above, Duncan Cotterill could not be said to have been independent. They were TENL’s lawyers at the time they acted in respect of the SA and continued to be up to and including the time of the termination of KT’s employment.
[89] For these reasons I find that it cannot seriously be argued that KT had independent legal advice at the time of the entry into the SA.
34 Carpet Barn Hamilton Ltd v Jobe [2017] NZHC 2608 at [25(b)]; AMP Services (NZ) Ltd v Visser
[2016] NZHC 134.
[90] It is noted that KT received a loan from RG to meet the cost of the legal advice from Duncan Cotterill with the loan being repaid from dividends on the shares. However that cannot transform Duncan Cotterill’s advice in to being “independent”.
[91] I also note that there is factual dispute between RG and JC on one hand and KT on the other as to whether the suggestion that KT use Duncan Cotterill came from RG or not. I am not called upon to resolve that issue now because, irrespective of whether the initiative to use Duncan Cotterill came from RG or JC (as JC has claimed), Duncan Cotterill was not independent.
[92] The plaintiff suggests that this case is “entirely consistent” with recent cases such as the Carpet Barn Hamilton Ltd v Jobe.35 I do not accept that. Firstly, there is a specific finding in that case that Ms Jobe obtained independent legal advice prior to entering into the relevant restraint.36 Another point of distinction is that the shares that Ms Jobe acquired were not paid for by her but the purchase price was advanced to her by way of interest free loan. It was what the Court describes as a “cash free deal for Ms Jobe”.37 Another fundamental difference between these cases is that Ms Jobe had gone to work for a direct competitor in the same market. Finally, the restraint was for only three months post employment.
Same or similar business
[93] The most significant issue for the determination of the interim injunction remains whether or not KT has gone to work for an employer in the “same or similar” business.
[94] At the hearing, Mr Gudsell conceded that the two businesses were not the same. That was an appropriate concession. There can be no serious argument that TENL’s business is not that of an electrical wholesaler. That is what it describes itself as and how it was identified by Richard McKnight in the PwC valuation. NZESL is not an electrical wholesaler, it is an electrical contractor. It is a customer of TENL and not, in relation to its electrical contracting work, a competitor to TENL.
35 Carpet Barn Hamilton Ltd v Jobe [2017] NZHC 2608.
36 At [5].
37 At [25(c)].
[95] RG has in fact expressly acknowledged that NZESL is a customer of TENL. He said:38
Telfer Electrical has brought an application for an injunction against Mr Trotter to prevent him from working for [TENL’s] customer because of the risk that it poses for [TENL’s] business.
[96] The defendants have tendered an affidavit from Graeme Alexander Guthrie a Professor of Economics in relation to market share and business formation. Professor Guthrie analysed the evidence in the affidavits and supporting documentation as to the nature of the respective businesses. He explained the concept of market structure and the fundamental differences between the economic activities undertaken in the varying sectors such as the manufacturing sector, the wholesale trade sector and the construction sector. He concluded that the principal business activity of TENL is as a stand-alone electrical wholesaler and that the economic activities of the two firms are fundamentally different.
[97] For the purposes of the interim injunction application it is necessary to consider whether the two businesses could be said to be similar so as to fall within the alternative limb of the restraint covenant.
[98] The principal fact put forward in support of the contention that the two businesses were similar was the reference to TENL engaging in lighting and switchboard designs. However, it seemed that to the extent there was lighting design work it was principally undertaken by a Christchurch-based employee of the Telfer Group. What activities other members in the Telfer Group undertake is irrelevant to this covenant in restraint of trade which is limited to the activities of TENL. I find that the allegation by JC that there was a “significant crossover” between the two businesses to be a substantial exaggeration.39 The fact that NZESL may buy products directly from the same manufacturers that TENL buys products from does not make the businesses similar. NZESL does not purchase product for on-sale to other contractors, it purchases product for use as part of its contracting business.
38 Affidavit of Ross Gordon, 30 May 2017 at [64].
39 Affidavit of Jason Collett, 22 November 2017 at [32].
[99]JC claims that NZESL:40
… buy a high majority of electric product direct from suppliers, we have [sic] and on sell it — with a labour component. That is the point of difference so we are similar, albeit, not the same.
[100] I find this is a wholly unrealistic way of describing the activities of a contractor. The activities of an electrical contractor cannot realistically be said to involve the wholesaling of electrical products “with a labour component”.
[101] TENL’s customers are contractors. If TENL’s customers perceived that TENL itself was operating as a contractor, it would inevitably lose their custom. To the extent that TENL provides services such as lighting or switchboard design that is to facilitate its business as an electrical wholesaler, to encourage contractors to purchase the electrical products it sells.
[102] I also note that there is no suggestion that, while at TENL, KT engaged in lighting or switchboard design. That is relevant when assessing the extent to which a customer connection between KT and TENL’s clients had been established so as to justify a period of freedom from competition for TENL. My conclusion is that, as KT does not appear to have been involved in these sorts of activities while at TENL he has no connection with TENL’s clients that requires restraint.
[103] The plaintiff claims that the “wholesaler vs contractor “distinction is artificial and unhelpful” and it is submitted that the Court is unlikely to obtain “substantial help” from Professor Guthrie’s evidence which should therefore not be admitted under s 25 of the Evidence Act 2006.41
[104] On the face of things, Professor Guthrie is appropriately qualified to give evidence as an expert. Section 25(2) of the Evidence Act 2006 does not render an opinion by an expert inadmissible simply because it is about an ultimate issue to be determined in the proceeding or a matter of common knowledge. Professor Guthrie concludes his evidence by saying:42
40 At [33.5].
41 Submissions of counsel for plaintiff, above n 31 at [13].
42 Affidavit of Graeme Alexander Guthrie, 15 November 2017, at [33].
There is no evidence in the plaintiff’s affidavit of any vertical integration by TENL into electrical contractual work, such as design and build projects, and installation, commissioning, and maintenance of the electrical products that it sells. My understanding is that any design work carried out by TENL is limited, and primarily outsourced and is for the purpose of TENL selling products to contractors and integrated contractor customers … .
[105] The conclusion reached by Professor Guthrie is that it cannot be said that the businesses of the two entities are similar. While the ultimate decision on that point is for me to make, I am able to derive some assistance from the academic analysis undertaken by Professor Guthrie of different markets and his analysis of the facts in this case. I find that his evidence is admissible and helpful.
[106] By way of summary, my conclusion on the issue of whether or not a seriously arguable question of law has been raised is that it is not seriously arguable that the businesses of the two entities are the same or similar for the purposes of the restraint.
Conclusion
[107] The restraint of trade which is sought to be enforced has not been drafted with a view to identifying the legitimate proprietary interest that needs protection and ensuring that the restraint provides as limited a restriction as necessary to protect that proprietary interest from unfair competition. This is compounded by the fact that as written, the period of restraint contended for (12 months commencing on the date that the second defendant is no longer a party to the shareholder’s agreement) has not yet started running given that the second defendant remains a shareholder and bound by the shareholder’s agreement.
[108] The restraint has two components; one is anti-competitive, the other is a non- solicitation restraint. No consideration has been given by the drafter of the restraint as to whether or not it is appropriate for KT to be restrained for equal durations in relation to both matters. While I have found valuable consideration was provided for the restraint, this is not a situation where parties of equal bargaining strength and each with access to independent legal advice entered into a commercial contract. There was an imbalance in the parties’ bargaining power and an absence of legal advice that could be described as independent. This case is distinguishable from cases such as
Fletcher Aluminium Ltd v O’Sullivan and it is not a situation where a business was sold in return for a substantial goodwill payment.43
[109] I have also considered whether it is possible that a restraint for a lesser period that 12 months from the date the defendants are bound by the shareholder’s agreement might be reasonable and the agreement modified accordingly. The only alternative mentioned by the plaintiff is 12 months from 14 February 2017. However, much of the reasoning as to why the restraint as drafted is not enforceable, applies to a restraint of this nature. Even if (contrary to my finding) it could be said that the two businesses were sufficiently similar so as to engage the restraint of trade provision, there is no evidence to explain why the plaintiff contends that 12 months is the minimum required to protect a particular proprietary interest. It is much longer than the three months in Carpet Barn and also much longer than the six month period that the plaintiff had indicated in the context of the unsigned MEA was appropriate to protect the plaintiff’s legitimate proprietary interests.
[110] For these reasons I hold that the plaintiff has not discharged the obligation on it to establish a seriously arguable question of law justifying the issue of an interim injunction.
[111] I note that the defendants have suggested that the plaintiff, in bringing these proceedings, is motivated by animosity and this application is in effect retribution for the plaintiff having lodged a claim for statutory holiday pay which the plaintiff contends is in breach of the settlement agreement reached before the MBIE mediator. In his oral submissions Mr Ironside went so far as to describe the case as one of “settlor’s remorse litigation”.
[112] This claim has some similarity to an argument advanced in the case of the Carpet Barn Hamilton Ltd v Jobe and there Brewer J indicated a claim of actuation by personal animus “could not be decided and weighed without oral evidence [and] should not have [been] given … the heavy weight” that it was in assessing the balance of convenience in the Court below.44 In relation to this matter, at this stage of the
43 Fletcher Aluminium Ltd v O’Sullivan [2001] 2 NZLR 731.
44 Carpet Barn Hamilton Ltd v Jobe [2017] NZHC 2608 at [36].
hearing I give no weight at all to this allegation. If the allegation is made out at the substantive hearing, then that may well affect the question of costs but is not a matter that the Court is able to resolve at this stage.
Balance of convenience
[113] As a result of the finding that I have made in relation to the issue of seriously arguable question, I do not need to go on and consider issues such as the balance of convenience, I however note that this is a case where I would have found that damages would have been an adequate remedy.
[114] The reason for this is that unlike almost all other restraint of trade cases, the principal measure of damages sought is not damages for the loss of customers. As is rightly noted in the plaintiff’s submissions and the cases referred to, damages in relation to that sort of loss can be difficult to prove and, when the Court gets to the stage of considering the balance of convenience, this is often a significant factor.
[115] However, in the present case the principal form of loss appears to be the contention of the plaintiff that, as a result of KT commencing employment with the NZESL, the amounts that NZESL has spent as a customer of TENL have decreased and the proportion of NZESL’s total spend on electrical products at TENL has also decreased. I am not required to resolve the disputed evidence on that point and it may well be that, in relation to the substantive matter, the Court accepts the evidence of RC that the variations in monthly purchases have explanations other than the inference that KT must have been influencing RC as principal of NZESL to reduce the company spend with TENL or to reduce the proportion of its overall spend with TENL.
[116] The amount of NZESL spend with TENL can be calculated easily and accurately as can the proportion of its overall spend. In that respect it cannot be said that damages would not be an adequate remedy.
[117] Accordingly the application for an interim injunction is dismissed. I invite the parties to settle costs as between themselves. My preliminary view is that costs should follow the event and they should be assessed on a 2B basis. However, if the parties are unable to agree as to costs I invite the defendants to submit a memorandum within
14 working days and the plaintiff to reply 14 working days after receipt of that memorandum.
Churchman J
Solicitors:
Cavell Leitch, Christchurch for Plaintiff Ironside Law Ltd, Brightwater for Defendants
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