Shareholders’ Agreements – Non-Compete Clauses…

Date Added 03.06.20

The issue of non-compete obligations has been recently examined by the Court of Appeal in the case of Guest Services Worldwide Ltd v Shelmerdine [2020] EWCA Civ 85. This case concerned the proper construction of restrictive covenants in a shareholders’ agreement and the duration of those restrictions.

The  Case:

Guest Services Worldwide Ltd (GSW) is a producer of maps for distribution to guests of luxury hotels. The business was originally founded by Mr Shelmerdine and had been acquired by GSW. Mr Shelmerdine was a shareholder in GSW and also supplied consultancy services to GSW. As a shareholder of GSW, Mr Shelmerdine was a party to a shareholders’ agreement with GSW and the other shareholders of GSW. The shareholders’ agreement contained a number of covenants, including a post termination non-competition covenant and restrictions in relation to the solicitation of clients, customers, employees and suppliers that applied for a period of 12 months after a party ceased to be a shareholder.

The consultancy agreement between GSW and Mr Shelmerdine was terminated in February 2019 and the articles of GSW required Mr Shelmerdine to offer to sell his shareholding in GSW to the other shareholders. Despite this, Mr Shelmerdine remained a shareholder at the time of the hearing in December 2019.

The case involved a contractual construction issue, but also and more interestingly, an issue concerning the duration of the restrictions. Mr Shelmerdine contended that because the covenants applied for 12 months after relinquishing shareholder status rather than from the date of termination of the consultancy agreement, they extended further than that which was reasonably necessary to protect GSW’s legitimate business interests. This case involved a consultancy arrangement, but similar considerations would apply in relation to employee shareholders and the termination of their employment.

Findings:

On the duration issue, the starting point for the Court of Appeal was the premise that all covenants in restraint of trade are unenforceable at common law unless they are reasonable, albeit that the court is likely to be less vigilant to this issue where covenants of this kind are contained in a shareholders’ agreement as compared to an employment contract. In this case the 12 month period was considered reasonable because:

  • GSW held a legitimate interest in seeking to prevent Mr Shelmerdine from competing with the business and soliciting clients, given the particular nature of the business and the knowledge that Mr Shelmerdine had obtained;
  • the restrictive covenants in the shareholders’ agreement had been made between experienced commercial parties; and
  • a period of restraint lasting 12 months was entirely reasonable to protect GSW’s interest.

The fact that the date of cessation of the services and the date of ceasing to be a shareholder were not the same and that some delay may occur in ceasing to be a shareholder, thus lengthening the restriction, did not overly perturb the Court. In its view, the possibility of a considerable delay or the shareholder being bound in indefinitely was unlikely.

Conclusion:

This case reinforces the fact that restrictive covenants in any type of agreement should be carefully drafted to capture employees, consultants, agents or directors that hold a shareholding within a company and do not inadvertently cause a duration problem. Employee shareholders should also consider any such restrictions in detail to ensure that they are not inadvertently agreeing to longer periods of restriction than they anticipate.

For more information, advice and guidance with shareholder agreements and restrictive covenants…Talk to Tollers Corporate and Commercial teams on 01438 901095 or contact enquiries@tollers.co.uk.

https://www.tollers.co.uk/commercial-law/commercial-contract-law/

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