Kao Lee & Yip v. John Richard Edwards

1992, No. A8680

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H E A D N O T E

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Action for an injunction and damages arising from breach of a restrictive covenant between the equity partners of a firm of solicitors and a salaried partner. Covenant held to be unenforceable as it was unreasonable as to area and time having regard to lack of mutuality of contract resulting in unequal bargaining power.

Bridge v Deacons [1984] 1 AC 705 which related to a partnership agreement between equity partners was distinguished.

1992, No.A8680

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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J U D G M E N T

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1. I have before me a preliminary issue as to whether a restrictive covenant in a partnership agreement between the partners of a firm of solicitors Kao Lee & Yip (the plaintiff), and John Richard Edwards (the defendant), who was formerly a salaried partner with the firm, is enforceable or whether it is an unreasonable restraint of trade and therefore void. A ruling that the covenant is unenforceable will result in the final disposal of the action.

2. Apart from one issue the facts are not seriously in dispute. The issue in dispute which is of no significance related to the number of times the defendant had been introduced to clients of the plaintiff on social occasions.

3. The plaintiff commenced business in 1981 with 3 partners and 14 staff. The firm has grown since that time to its present size of 7 partners of whom 4 are equity partners and 3 are salaried partners, 20 assistant solicitors and 170 staff. It has departments dealing with litigation, conveyancing, company/commercial, finance and banking and town planning/land.

4. The defendant was admitted as a solicitor in England in 1981 and in Hong Kong in 1982. He joined the plaintiff as an assistant solicitor in November 1987 having worked for four other firms in Hong Kong before that time. As an assistant solicitor with the plaintiff the defendant was engaged in general litigation work with the litigation department which serviced the entire client base of the firm. Between fifty and sixty per cent of the litigation work is generated by existing clients, principally 15 banking clients of which according to Mr Kao, the plaintiff's senior partner, 8 or 9 are international and the rest are local. The banking clients in fact provide fifty to sixty per cent of the firm's total work including sixty per cent of the conveyancing business.

5. Mr Kao emphasised the international nature of the plaintiff's business by reference to the international banking clients and to the fact that the firm acts for a state corporation in China and that it intends to open a branch office in Shanghai. He went on to say that the plaintiff has also made approaches to open other branches overseas but so far has not achieved any success in this respect.

6. When he joined the plaintiff, the defendant entered into an employment contract containing a restrictive covenant which provided that for three years from termination of the employment he could not do any work of a solicitor nor solicit business from anyone who shall have been a client of the firm for a period of three years prior to the date of termination.

7. On the 1st July 1989, the defendant was admitted as a salaried partner by the plaintiff under the terms of a salaried partnership agreement dated the 28th June 1989 entered into between the defendant and the equity partners of the plaintiff. The partnership agreement contained a restrictive covenant that was similar to the covenant in the employment contract, but with the period of restraint increased from three to five years. The restrictive covenant also applied to the equity partners. The relevant part of the covenant is set out in paragraph 17 of the partnership agreement which reads as follows :-

"17. Upon the termination of this Deed and unless the Salaried Partner shall immediately upon such termination be admitted into full equity partnership with the Equity Partners, the Salaried Partner shall not for the space of five (5) years from the date of such termination directly or indirectly :-

(a) solicit legal business from, or do any work or act normally done by solicitors for, any person or firm or corporation who or which shall have been a client of the Practice (which expression includes the partnership practice of Kao, Lee & Yip being carried on before the date of this Agreement) at any time within a period of three (3) years immediately preceding the date of such termination ....;

(b) ......"

The restrictive covenant was modelled on the covenant that was used in Bridge v Deacons [1984] 1 AC 705 at 712 except that the covenant in that case was restricted to Hong Kong.

8. When he entered into the partnership agreement, the defendant became the plaintiff's litigation partner.

9. It was as a result of the expansion of the partnership that the plaintiff decided to introduce the concept of salaried partnership usually from within the existing ranks of assistant solicitors of the firm which was regarded as an intermediate stage between that of an assistant solicitor and a full partner. As a salaried partner, the defendant did not share in the profits or losses of the firm, but received a substantial increase in salary from that paid to him as an assistant solicitor together with a bonus payable at the discretion of the two founding partners, Mr Kao and Mr Yip. His responsibilities increased for he now had authority to sign correspondence and other professional communications whilst files were opened under the references of salaried and equity partners without differentiation. He was described on the firm's stationery as a partner which revealed no distinction between a salaried partner and an equity partner. In addition he had a free hand to entertain and promote clients and attended some of the client functions of the firm as a partner. Indeed to the outside world the defendant was ostensibly no different from the equity partners. However, he had no power of control or management in the business nor did he make any capital contribution to the assets of the firm.

10. The defendant gave notice to terminate the partnership in March 1991 and by agreement between the parties, the defendant left the firm on the 15th July 1991.

11. After he left the plaintiff, the defendant joined another firm of solicitors Alsop Wilkinson as an assistant solicitor and later became a consultant to that firm.

12. Whilst the defendant was employed by the plaintiff, he dealt with a wide cross-section of the plaintiff's clients including its banking clients. One of these clients was the Bank of America National Trust and Savings Association (the bank) which had been a regular client of the plaintiff since 1983. The plaintiff is one of the bank's principal legal advisers in Hong Kong and the plaintiff regards it as one of its valued and long standing clients. The defendant whilst working for the bank became acquainted with Mr Michael Coale, an associate general legal counsel of the bank and developed a close working relationship with him. A matter that was handled by the plaintiff for the bank was a High Court Action against the bank by a company named Zanda Investment Limited, but the defendant was not concerned with this case. However, on the 18th August 1992, the plaintiff received a letter from Alsop Wilkinson, informing them that they had been instructed by the bank to take over the conduct of its defence in the Zanda case. Mr Kao later ascertained that the defendant was handling the Zanda action at Alsop Wilkinson on behalf of the bank.

13. After Mr Kao became aware that the defendant was dealing with the Zanda case, letters were written by the plaintiff to Alsop Wilkinson referring to the restrictive covenant, but replies were received to the effect that it was contended that the restrictive covenant was void and unenforceable. As a result, the present proceedings were issued seeking injunctive relief and damages for breach of the partnership agreement.

14. Mrs Alexa Lam who is an equity partner with the plaintiff gave evidence that when the partnership agreement was entered into with the defendant the plaintiff would have considered any reasonable requests for an amendment to the agreement, with the exception of the restrictive covenant which she believes the partners would not have agreed to any amendment or deletion.

15. No evidence was given by the defendant nor were any witnesses called on his behalf.

16. It is the plaintiff's case that the covenant is not intended to prevent the defendant from practising law in Hong Kong or competing with the plaintiff, but was merely designed to protect the plaintiff's goodwill.

17. Covenants in restraint of trade are unenforceable unless the covenant is reasonable in the interests of the parties and in the public interest. The onus is upon the plaintiff to establish that the covenant is reasonable and if this is proved, the burden shifts to the defendant to show that it is not in the public interest. Reasonableness was explained in Herbert Morris Limited v Saxelby [1916] AC 688 at 707 where Lord Parker of Waddington had this to say:-

"To be reasonable in the interests of the parties the restraint must afford adequate protection to the party in whose favour it is imposed; to be reasonable in the interests of the public it must be in no way injurious to the public.

With regard to the former test, I think it clear that what is meant is that for a restraint to be reasonable in the interests of the parties it must afford no more than adequate protection to the party in whose favour it is imposed."

The law on this subject is usually considered under two categories, that of vendor and purchaser with which this case is not concerned, and employer and employee.

18. At first instance, Hunter J. in Bridge v Deacons No.1530/1983 described the partnership cases as being different from those of vendor and purchaser and employer and employee, but sui generis when he had this to say at p.11 of his judgment:-

"The partnership cases, on the other hand, are somewhat different again and have been described as sui generis. The unique quality about these is this. In all the other cases, the parties have been in the same capacity and in one capacity only. The master doesn't become the servant and the vendor doesn't become the purchaser. But the unique feature of the partnership cases is that the partners are in it potentially in two capacities. When they enter into these agreements they don't know at the time they enter into them, whether they are looking at it as a potential retiring partner or as a potential subsisting partner. They tend to be entered into by persons at arm's length."

19. Mr Chang, counsel for the plaintiff, places great reliance on Bridge v Deacons (supra) where the Privy Council dismissed an appeal from the Court of Appeal's decision upholding the judgment of Hunter J. who had granted inter alia an interlocutory injunction restraining Mr Bridge, a full equity partner in the firm of solicitors, Deacons, without the written consent of the firm acting as a solicitor in Hong Kong for five years for any person, firm or company who was at the time of his ceasing to be a partner or had, during the previous period of three years, been a client of the firm. The Privy Council held that whether a covenant in restraint of trade was enforceable as being reasonable in the interests of the parties and the public interest was to be determined by a consideration of the legitimate interests of the business which were in the assets and goodwill of the partnership as a whole. The Privy Council decided that the period of restraint for five years was reasonable for the partnership agreement had been drawn up by experienced solicitors in order to protect the goodwill of the firm which is the most valuable asset owned by the partners.

20. Mr Chang went on to submit that the instant case does not fall within the employer/employee category for a salaried partner is not only an employee but enjoys the benefits of being presented to the world as a full partner without being exposed to the liabilities of full partnership. In considering the issue of reasonableness, he argued that the proper approach is to ascertain what were the legitimate interests which the covenantee was entitled to protect and then to see whether the restraint was more than adequate for that purpose. In support of this submission he cited the following passage from the judgment of Lord Fraser of Tullybelton in Bridge v Deacons (supra) where he had this to say at p.714 :-

"The agreement in the present case, being one between partners, does not conform exactly to either of the types to which reference has just been made, although it had some resemblance to both. Their Lordships are of opinion that a decision on whether the restrictions in this agreement are enforceable or not cannot be reached by attempting to place the agreement in any particular category, or by seeking for the category to which it is most closely analogous. The proper approach is that adopted by Lord Reid in the Esso Petroleum case [1968] A.C. 269, where he said, at p.301:

'I think it better to ascertain what were the legitimate interests of the appellants which they were entitled to protect and then to see whether these restraints were more than adequate for that purpose.'

What were the respondent's legitimate interests will depend largely on the nature of their business, and on the position of the appellant in the firm."

21. Further, in assessing the validity of the covenant, one of the most important factors to be considered is the issue of mutuality. On this aspect, Lord Fraser had this to say at p.716:-

"On this question the mutuality of the contract is a most important consideration. The contract applied equally to all the partners. None of them could tell whether he might find himself in a position of being a retiring partner subject to the restriction in clause 28, or of a continuing partner with an interest to enforce the restriction. It was at least as favourable to the appellant as to the more senior partners; ..."

22. Mr Chang also relied on Clarke v Newland [1991] 1 All ER 397 to the effect that a professional person's practice is the proper object of a covenant in restraint of trade in a partnership agreement. In fact, it is common ground in this case that the plaintiff is entitled to a restrictive covenant for the protection of his legitimate interests, provided that it is reasonable.

23. Mr Bleach, on the other hand, submitted that Bridge v Deacons (supra) is not relevant for the defendant is not an equity partner in as much as there was a lack of mutuality between the parties that resulted in unequal bargaining power. Accordingly, he asserted that the case properly falls within the category of employer and employee.

24. The covenant in Bridge v Deacons (supra) was held to be reasonable, both as to area which was restricted to Hong Kong and to a time limit of five years because the parties entered into the agreement with equal bargaining power and each of the partners had an interest in the goodwill and assets of the firm. In this case, the defendant did not have equal bargaining power as was made clear by the evidence of Mrs Alexa Lam that the partners would not have agreed to any amendment of the covenant. Further, although the defendant entered into a covenant with the partners, they did not enter into any mutual covenant with him. It is significant as I have said that the restrictive covenant equally applied as between the equity partners as well as with the defendant. The defendant, although held out to the world as a partner, did not have the benefit of a share of the profits nor any interest in the goodwill. Neither did he share in the risks or liabilities of the firm. His effective benefits were limited to an increase in his salary and a bonus which was, however, only payable at the discretion of Mr Kao and Mr Yip.

25. As there was a lack of equal bargaining power and the defendant did not, as a salaried partner, share in the risks and benefits of the partnership and had no interest in the goodwill or assets of the partnership, the reality of the defendant's position with the plaintiff was that of employer and employee. Accordingly, the plaintiff is only entitled, as a matter of law, to reasonable protection of its legitimate interests to the goodwill of the business under the covenant having regard to the facts at the time when the covenant was made see Clarke v Newland (supra) at p.402g. The fact that the defendant might have become an equity partner later is irrelevant.

26. The effect of the covenant is that the defendant cannot, for a period of five years, act for any client anywhere in the world where that client is or has been at any time, during the three years preceding the termination of the agreement in which the covenant is contained, a client of the plaintiff. Mr Kao conceded that he had no legitimate interest to protect in other parts of the world and that the covenant was impliedly restricted to Hong Kong. In fact Mr Chang urged me to accept his alternative argument that it would be reasonable if so restricted. Indeed it is clear that the object of the covenant was to operate worldwide. However, the legitimate interests of the plaintiff do not require this protection for although it deals with work that has an international connection, it is not an international firm for it does not have branch offices overseas or connections with any overseas firm. It is in fact a successful local firm with some international connections.

27. Further, having regard to the authorities when a covenant is unlimited, the covenant cannot be rewritten to limit its territorial extent see Dowden & Pook Ltd. v. Pook [1904] 1 KB 45,Vancouver Malt v Vancouver Breweries [1934] AC 181, Commercial Plastics Ltd. v Vincent [1965] 1 QB 623, and J.A. Mont (UK) Ltd v Mills (English Court of Appeal, Unreported 30.10.92). The clause is unambiguous and can only be described as too wide for it relates to all the clients of the plaintiff on a worldwide basis.

28. As was submitted by Mr Bleach, restrictions will be enforced if the protection sought is reasonably necessary to prevent some personal influence over customers being abused in order to entice them away see Faccenda Chicken Limited v. Fowler [1986] ICR 297 per Neill L.J. at p.310F. My attention was also drawn to Ho Wing-cheong and Ors. v Graham Margot and Anr. [1991] 1 HKLR 245 where at pp.249 and 250 Godfrey J. said :-

"The restraint will be reasonable only if its duration is no longer than necessary -

(1) for the employer to put a new man on the job and for the new employee to demonstrate his effectiveness to customers; and

(2) to prevent an employee who has quit the territory from returning to acquire the employer's business.

... I have no doubt that in Hong Kong in 1985 the plaintiffs did not need a restriction of 3 years to achieve their legitimate objects. One year would have been ample to break the connection of Mr Margot with the plaintiffs clients 'for a sufficient period to let the next man obtain the connection' : see Middleton v Brown (1878) 47 LJ (NS) 411, per Jessel, M.R. at p.413."

29. Although I accept as was contended on behalf of the plaintiff that the damage that the defendant can do or has done to the plaintiff by taking clients away is identical to that of an equity partner because a client would not be aware who was a salaried partner and who was an equity partner a restriction of five years which was accepted to be reasonable between equity partners in Bridge v Deacons (supra) which was incorporated by mutual agreement is excessive as between the equity partners of the plaintiff and the defendant as a salaried partner. The court, however, is not entitled to substitute a lesser period for the one that was included in the covenant.

30. Mr Bleach submitted that although in theory it is open to the court to sever or blue-pencil the words in the covenant "or do any work or act normally done by solicitors for" so that the covenant could be saved insofar as it prohibits solicitation I accept that it would not be appropriate to do so as the prohibition against solicitation will still be subject to a five year period and such a period cannot be regarded as reasonably required to protect the plaintiff's legitimate interests.

31. It is clear that when Mr Kao drew up the partnership agreement and relied upon the restrictive covenant in Bridge v Deacons (supra), he overlooked the fact that the partners in that case were equity partners with equal bargaining power. As the defendant did not have mutuality of contract or have any interest in the goodwill or assets of the partnership, the restrictive covenant, in order to satisfy the test of reasonableness, should have taken these matters into account. However, the covenant, as drawn, is unreasonable both as to area and as to time so that it is unenforceable and void.

32. The action will accordingly be dismissed and there will be an order nisi for costs to the defendant.