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The importance of incorporating clearly drafted non-compete covenants into a business purchase agreement has been demonstrated by a recent High Court case, according to a corporate lawyer.
“Courts are more likely to uphold restrictive covenants in a business sale agreement than those in an employment contract, and are reluctant to strike down clauses freely negotiated between parties of comparative commercial standing,” says Philip Round, a partner at George Green LLP’s Wolverhampton office. “Nevertheless, a clause which goes beyond what is considered reasonable to protect the goodwill of the target business will be void as an unenforceable restraint of trade.”
Mr Round continues, “the case of Rush Hair Ltd v Gibson-Forbes & Anor concerned the defendant franchisee of a hairdressing salon who had sold the business to the franchisor and entered into certain covenants not to compete with the franchisor for a two year period within a certain geographical area and not to solicit or employ certain named employees within that period. Before the two year period had expired, the defendant incorporated a company for the purpose of operating a competing salon within the restricted geographical area. She also entered into a consultancy contract on behalf of the new company with one of the prohibited employees, pursuant to which the employee was engaged as the head stylist at the competing salon. When the franchisor brought proceedings for breach of the clause, the defendant claimed that the non-compete covenants only prevented her from competing in her personal capacity, rather than through a limited company.”
According to Mr Round, the court decided that the covenant applied to actions carried out by the defendant directly or via a corporate vehicle “The court held that, whilst the clause did not distinguish between competing activities carried out by the defendant directly, and indirectly as a shareholder and officer of a company, the clause should be interpreted in light of the parties’ awareness that the defendant customarily carried on business through a company. The only commercially sensible meaning of the clause was that it should apply to the defendant personally and to the actions of her corporate vehicle. As two year covenants were considered reasonable in the content of a business sale where the defendant and her employees had generated significant goodwill during the term of the franchise arrangement, the covenants were held to be enforceable.”
Mr Round concludes, “whilst the covenants were held to apply in the circumstances, arguments over their application to activities carried out by the defendant through a corporate vehicle could have been avoided had the wording of the clause expressly addressed this scenario. It is therefore important that professional advice is sought on the wording of non-compete covenants, particularly on the sale of a service business where personal relationships are crucial.”