In this update: draft corporate transparency legislation, a merger is blocked by the European Commission despite the target generating no EU revenue, a post-termination restrictive covenant was not enforceable and the FRC publishes an updated list of signatories to its Stewardship Code.

Government introduces second Economic Crime Bill into Parliament

The Government has introduced draft new legislation, in the form of the Economic Crime and Corporate Transparency Bill, into Parliament.

The Bill proposes to meet various Government objectives, including the following.

  • Delivering reforms to the role and powers of Companies House, which follows the Government’s white paper on reforming the register. (For more information on that white paper, see our previous Corporate Law Update.)
  • Introducing reforms to limited partnership law to prevent the abuse of limited partnerships.
  • Creating additional powers to seize and recover suspected criminal cryptoassets and introducing modifications to the UK’s existing anti-money laundering framework.

The Bill is at an early stage and is scheduled for a second reading in the House of Commons on 13 October 2022. We will explore the detail of the Bill in next week’s Corporate Law Update.

European Commission blocks Illumina/Grail merger

In July 2022, we reported that the General Court of the European Union had cleared the way for the European Commission to investigate the proposed merger of Illumina and Grail under EU law.

The referral was significant because the target enterprise – Grail – does not generate any revenues in Europe and so was not subject to a filing obligation under the EU merger control regime.

Instead, the referral was made under Article 22 of the EU Merger Regulation. This allows a Member State to refer a transaction that affects trade between Member States and “threatens to significantly affect competition” within a territory, irrespective of the extent of the target enterprise’s sales or assets.

Once nearly defunct, the Commission now encourages Member States to refer transactions under Article 22 if they involve a target whose competitive potential is not reflected in its turnover. This, in turn, provides a mechanism for the Commission to review so-called “killer acquisitions”.

As it so happens, following the referral, the Commission has decided to block Illumina’s proposed acquisition of Grail, citing concerns about the impact of the deal on the emerging market for early cancer detection tests.

For more information on the decision and its impact in practice, see this blog by our colleagues, Rich Pepper and Ciara Barbu-O’Connor.

Restrictive covenant was invalid because there was no interest to protect

The Court of Appeal has held that a non-compete covenant that commenced when a marketing arrangement between two companies ended was unenforceable, because there was no longer any legitimate interest for the covenant to protect.

What happened?

Credico Marketing Ltd v Lambert [2022] EWCA Civ 864 concerned a company (Credico) whose business was to organise direct or face-to-face marketing campaigns on behalf of its clients.

Credico did not carry out direct marketing itself. Instead, it contracted marketing companies based across the United Kingdom, which would in turn recruit and sub-contract sales representatives to approach potential customers. Once a potential customer was found, the direct marketing would be carried out for the customer by the marketing company and its sales representatives.

Credico would enter into a standard-form “trading agreement” with each of its marketing companies, under which it would supply the marketing company with a “ready-made stream of campaigns”, as well as certain ancillary services, including guidance, back-office services and arranging banking and insurance facilities.

The trading agreement contained two non-compete covenants (a type of restrictive covenant), to be given by the marketing company, preventing it from competing with Credico. The first covenant was stated to apply both throughout the term of the agreement and the second (the “post-termination covenant”) for six months after the trading agreement was terminated.

Credico also required the owner of each marketing company to enter into a separate guarantee, agreeing to guarantee that the marketing company would comply with the trading agreement, but also applying the non-compete covenant to the owner of the marketing company as well as the marketing company itself.

One of the marketing companies used by Credico was S5 Marketing, which was owned by Mr Lambert. S5 entered into the required trading agreement and Mr Lambert entered into the required guarantee.

Subsequently, Credico claimed that, around ten years later, S5 and Mr Lambert had breached the non-compete covenants by assisting S5’s sales representatives to conduct door-to-door sales campaigns for third parties, including for one of Credico’s rivals.

The High Court found that S5 and Mr Lambert had breached the non-compete covenants, both during the term of the agreement and during the six-month period after it had come to an end. S5 and Mr Lambert appealed to the Court of Appeal, claiming that the restrictive covenants were unenforceable.

Under English law, a restrictive covenant will be unenforceable unless it is reasonable by reference to the legitimate interests of the parties concerned and the interests of the public. When deciding whether a covenant is reasonable, a court will look at various factors, including what the covenant is looking to achieve, its duration and breadth, the parties’ bargaining power and whether the restriction impacts the public. However, the court is not limited in the factors it can take into account.

What did the Court of Appeal say?

The court found that the non-compete covenant that applied during the term of the trading agreement was valid. It reflected the fact that Credico was investing time, money and opportunities in S5, which justified requiring S5 to work exclusively for Credico. This was a legitimate interest to protect.

The post-termination covenant, by contrast, was not valid. Sir Patrick Elias, who delivered the court’s judgment, gave the following reasons (among others):

  • Once a trading agreement comes to an end, Credico will no longer be investing in a marketing company. It cannot expect the marketing company’s workforce to continue to be available to it. To justify the post-termination covenant, therefore, Credico requires some other legitimate interest that the covenant is protecting.
  • Credico had no goodwill, know-how or confidential business information to protect (interests that might traditionally justify a non-compete covenant). This was because Credico effectively acted as a pass-through between its own clients and the marketing companies.
  • Any training and support Credico provided to S5 was specific to individual campaigns assigned to S5. Once those campaigns ended, the support was of no value. There was, therefore, no “quid pro quo” justifying a post-termination restriction on S5.
  • It was not reasonable, following the end of the trading agreement, to prevent S5 or Mr Lambert from working on a campaign for one of Credico’s competitors for which S5 and Mr Lambert did not gain any prior insight as a result of their previous relationship with Credico.

The court also dismissed the argument that the trading agreement was more akin to an “employment” relationship between Credico and Mr Lambert (with Mr Lambert using S5 as a vehicle to provide his own person services to S5). This was relevant because, traditionally, the courts have been more likely to strike restrictive covenants down as unenforceable in the context of an employment arrangement.

What does this mean for me?

This is a good example of how the courts will not allow parties to impose non-compete restrictions liberally merely to stifle competition against their own business.

The decision highlights familiar points that a person seeking to extract the benefit of restrictive covenants should consider.

  • There will often be clear justification for imposing non-compete and other restrictive covenants during the lifetime of a commercial arrangement. However, once that arrangement has ended, a person seeking to impose post-termination restrictive covenants will need to be able to identify some legitimate interest which the covenants are designed to protect.
  • Whether such an interest in fact exists is ultimately a matter for the court to decide. However, a party can increase the likelihood of enforceability by including an express reference in the relevant contractual documents to the interest the covenants are attempting to protect.
  • Interests that might typically justify a post-termination covenant include protecting goodwill and ensuring the confidentiality of know-how and business information.
  • Finally, when negotiating restrictive covenants, it is always important to ensure the covenant goes no further than reasonably necessary to protect the relevant interest, including in terms of duration and geographical extent.

A further comment on the question of timing

The court also considered a separate and interesting point around timing.

S5 and Mr Lambert had not originally entered into the trading agreement and guarantee with Credico, but rather with a company called PerDM. PerDM sold its business to Credico in 2016 and, as part of that sale, the trading agreement was “novated” to Credico. (For more information on novation, see our summary of Gama Aviation (UK) Ltd v MWWMMWM Ltd in our previous Corporate Law Update.) At the point of novation, the agreements with PerDM ended and S5 and Mr Lambert entered into new (identical) arrangements with Credico.

The court must assess whether a restrictive covenant is reasonable by looking at the circumstances when the contract was originally concluded. The question here was whether the appropriate time for assessing the covenants was when S5 and Mr Lambert originally contracted with PerDM or when the new arrangements was formed upon the novation to Credico.

The decision on this point could, in theory, have made a big difference, as S5 and Mr Lambert were arguably more experienced and had stronger bargaining power at the time of the novation than when they initially contracted with PerDM.

The High Court found that the appropriate reference point was when S5 and Mr Lambert originally contracted with PerDM. The Court of Appeal acknowledged that this was an “arguable point”. However, the judges did not need to explore the issue again: if S5 and Mr Lambert were in a stronger position by the time of the novation, this would only serve to add further justification for enforcing the covenants, which the High Court had already found were enforceable.

If the High Court’s analysis is correct, it has a substantial consequence for a willing buyer of a business that is conducting diligence on a target. To be able to assess the enforceability of restrictive covenants in the target group’s contracts, a buyer will need to understand the precise factual circumstances surrounding each individual contract when it was made. This will be particularly relevant to target businesses that are heavily based around relational contracts (i.e. contracts that have an element of duration and involve mutual trust between the parties).

FRC publishes updated list of Stewardship Code signatories

The Financial Reporting Council (FRC) has published an updated list of signatories to the UK Stewardship Code following its Spring 2022 assessment. The FRC added 43 new signatories, taking the total number of signatories to 236.

The Code sets out what the FRC considers best practice for institutional asset owners and asset managers when exercising their stewardship responsibilities. Like the FRC’s UK Corporate Governance Code, it operates on a “comply or explain” basis. Certain asset managers are required to report against the Code under the Financial Conduct Authority’s Conduct of Business Sourcebook. Other institutional investors can apply to become “signatories” to the Code and adopt it voluntarily.

The FRC introduced the current version of the Stewardship Code in late 2019, to take effect from 1 January 2020. The current version expands substantially on previous versions of the Code, applying not only to asset owners, but also asset managers (including pension funds) and service providers, and covering all kinds of capital (both publicly traded and privately held).

The FRC notes that signatories reporting for their second year had in most cases used the feedback they received to improve their reporting this year. It saw improvements in several areas, such as the quality of activity and outcome reporting, contributions to addressing market wide and systemic risks, and reporting on how signatories monitor third parties and hold them to account