Shareholders’ agreements frequently contain restrictive covenants to safeguard the company’s confidential information, commercial relationships and goodwill. Common examples include non-compete clauses, which limit a shareholder’s involvement in competing activities, and non-solicitation clauses, which prevent shareholders from targeting the company’s customers, clients, suppliers or other business contacts. These restrictions may apply both during the shareholder’s ownership and for a defined period following their departure, provided they are drafted reasonably and are enforceable under the law.
Restrictive covenants are most commonly used in situations where a company seeks to prevent departing shareholders or employees from establishing competing businesses and diverting clients or commercial opportunities. They are also frequently used in business acquisitions, where a buyer may require sellers to agree not to immediately establish or become involved in a competing venture following the sale of the company.
Court decisions regarding restrictive covenants tend to be fact specific, and providing they are reasonable, are enforceable. However, the interpretation of reasonableness can be broader when the courts assess commercial contracts than some other areas of law because of the higher bargaining power and shareholders having direct stakes in the performance of the business.
Enforceability
For a restrictive covenant to be exercisable under UK law, there must be a valid interest that the company seeks to protect. In addition, the extent of the restraint must not be more than only what is necessary to protect that interest.
The enforceability of a restrictive covenant will depend not only on its scope but also on the period for which it operates. Where restrictions relating to competition, solicitation or the diversion of commercial opportunities extend beyond what is reasonably necessary to protect legitimate business interests, the courts may consider them excessive and refuse to enforce them. In determining the reasonable amount of time where the covenant is enforceable, the relationship between the parties is taken into account, and includes consideration as to whether the parties are individual employers and employees, or experienced commercial personalities.
Scope
The scope of a restrictive covenant is another key factor in determining its enforceability. It must strike an appropriate balance between protecting the company’s legitimate interests and ensuring that the shareholder is not subject to unnecessary or excessive restrictions. A covenant that is drafted too broadly may be considered unreasonable, while one that is too narrow may fail to provide adequate protection for the company. Factors such as the duration of the restriction, the activities being restricted and the category of individuals subject to the covenant will all influence the precise terms and enforceability of the provision.
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