In this issue we look at a recent case on non-solicitation and non-compete covenants when buying a business, as well as updated guidance from the Investment Association on executive remuneration.

RESTRICTIVE COVENANTS ON SHARE SALES NO GETTING ROUND THEM?

The High Court has held, in Rush Hair Ltd v Gibson-Forbes & anor [2016] EWHC 2589 (QB), that a seller breached non-solicitation and non-compete covenants in a share sale agreement, even though the employees in question were employed by a company owned by the seller, not the seller herself.

Facts

Hayley Gibson-Forbes ("HGF") developed a successful hairdressing business over a number of years through two sites under a franchise arrangement with Rush Hair Ltd ("Rush").

In March 2015, she agreed to sell the companies running those franchises to Rush. The share sale agreement (SPA) contained restrictive covenants requiring HGF not to:

  • canvass, solicit, entice or employ three named individuals (the "non-solicitation covenant"); or
  • be employed or interested in a business similar to Rush's within a two-mile radius of the sites (the "non-compete covenant").

Each covenant was given for a period of two years.

In July 2016, HGF opened a new salon in Windsor through a new company ("SJFL"). She and her husband were the sole directors of SJFL.

SJFL engaged one of the three named individuals as a consultant and the other two individuals as employees. Rush claimed this put HGF in breach of her restrictive covenants in the SPA.

HGF claimed that the two-year time period and (in relation to the non-compete covenant) the two-mile radius went further than reasonably necessary. She said this rendered the restrictive covenants too wide and therefore unenforceable.

She also claimed there was no breach of the non-solicitation covenant, because the covenant applied to her personally. However, it was SJFL that had employed the three individuals, and SJFL was not bound by the non-solicitation covenant.

Legal background

Non-compete and non-solicitation covenants are common in SPAs, employment agreements and other commercial contracts (such as franchise agreements). They are generally enforceable, provided they are no wider than reasonably necessary to protect a legitimate interest.

Restrictive covenants in sale agreements are normally subject to less scrutiny than those in employment agreements. This recognises the special nature of an employer-employee relationship, versus the need to protect goodwill on a sale.

When a contractual term is ambiguous, the court may give it the meaning the contract would convey to a reasonable person having all the background knowledge.

Decision

On one reading, the non-solicitation covenant appeared only to prevent HGF from soliciting or employing the individuals on her own behalf (and not through a company). However, the judge thought the covenant was ambiguous and he was required to give it a "commercially sensible meaning".

He found the parties knew that HGF had historically used companies to conduct her business and had this in mind when negotiating the SPA. With that in mind, a covenant that applied only to HGF would have been "toothless". It must have been intended to apply to HGF acting on her own behalf or as agent for someone else.

On the facts, HGF had acted as SJFL's agent in employing the three individuals. (This included the individual engaged as a consultant. The court felt the restriction included consultancy arrangements.)

The court also had no hesitation in finding that HGF had also been interested in a competing business.

The question, therefore, was whether the covenants were enforceable. The court said they were.

The court found that the two-mile radius of the non-compete covenant was not a hindrance to HGF. Indeed, HGF lived within that radius, but that had not stopped her from running a salon on a nearby site outside the radius. In the court's view, this suggested that the geographical restriction in the non-compete covenant had not gone further than was necessary to protect Rush's business.

Furthermore, there was no reported case law stating that a covenant in an SPA could be unreasonable solely on the grounds of duration. In employment cases, restrictive covenants usually last for a shorter period, but this is because different considerations apply.

The court therefore found that HGF had breached the restrictive covenants.

Practical implications

The outcome of the case is obviously good for buyers. Although the case related to a share sale, the same principles will apply equally on a business sale.

It will still be important to consider each restriction in turn to ensure it does not go beyond what is reasonably necessary to protect the buyer's legitimate interests, but buyers should feel comfortable that courts will take a sensible and reasoned approach when enforcing these covenants.

In particular, persons entering into restrictive covenants should not assume that they can by-pass those restrictions merely by using a corporate vehicle. The courts will likely find a way to defeat this.

The court's comments on the duration of restrictive covenants are interesting. In theory, there may be no upper time limit beyond which non-solicitation and non-compete covenants become unenforceable. However, these covenants will often be limited to two or (sometimes) three years to avoid breaching UK and EU competition law.

In addition, employers should not rely on this case to extend restrictive covenants in an employment context with their employees. Different factors generally apply to employment contracts, and covenants will be scrutinised much more carefully by the courts.

INVESTMENT ASSOCIATION REVISED PRINCIPLES OF REMUNERATION

The Investment Association has produced its revised principles of remuneration, which will apply to the 2017 reporting season. A copy of the revised principles can be found here.

There are some substantial changes, including re-framing the principles in the form of high-level topics. Specific changes include:

  • The requirement for a simple remuneration structure has been replaced by a recommendation that the remuneration structure be appropriate for the company's business strategy.
  • When assessing whether executive remuneration is appropriate, committees should use the ratio of median employee remuneration to executive remuneration as their reference point.
  • If directors are required to hold a minimum shareholding in their company, they should continue to hold a proportion for a period of time after leaving the company.