When a company is sold, the terms of the sale are usually set out in a share purchase agreement (SPA). A buyer will often require a seller to enter into restrictive covenants in the SPA so as to protect the target company from the damage which the seller could inflict on its business by engaging in competitive behaviour.
For example, a seller will typically be prevented from dealing with particular customers, soliciting certain suppliers, operating within a defined geographical area or poaching key employees for an agreed period of time.
In Rush Hair Ltd v Gibson-Forbes & Anor, the High Court considered two restrictive covenants:
- a non-solicitation and non-employment covenant prohibiting the seller from canvassing, enticing or employing several named employees for a period of two years
- a non-compete covenant restricting the seller from engaging or being interested in any business similar to or competitive with the buyer's business, within a two mile radius of any existing salon
The main points of the High Court's judgment were:
- Before the Court could accept the buyer's claim that the seller used a newly-incorporated company as a "device to get round the restrictive covenants", the judge would need evidence that the seller had pierced the corporate veil or, in other words, that a company had been created with the purpose of defeating the enforcement of a legal right. There was no such evidence in this case.
- The Court said that the non-solicitation and non-employment covenant was ambiguous and gave it an expansive interpretation. The only way to give the clause a commercially sensible meaning was by prohibiting the seller from carrying out the restricted activities both on her own behalf and as an agent for another.
- The Court rejected the seller's arguments that the buyer's acceptance of an earlier breach of the non-solicitation and non-employment covenant by the seller had the effect of excusing her from further compliance with the SPA.
- Overall, the Court considered the two covenants to be enforceable as they were found to be reasonable in terms of the protection they granted to the legitimate business interest of the buyer.
This case is a helpful reminder for both buyers and sellers of businesses that restrictive covenants require careful drafting and need to be considered in the context of the target business rather than on a 'one size fits all' basis.
For more information, please contact Emma Cameron on 01923 919 305.