Restrictive covenants (sometimes called "non-compete clauses") are commonly used in corporate transactions such as company and business acquisitions, or investments. They protect the business interests of the target company (and, by extension, the buyer or the investor). These covenants place limitations on the seller's / key individual’s activities following completion of the transaction to prevent competition with the target for a specified period.
Although restrictive covenants are more readily enforceable in a commercial context than in an employment context, they still need to be reasonable, and a recent case has highlighted just how important that is.
What are the typical restrictions?
Common types of restrictions include:
- Non-compete restrictions which prevent the relevant party from working for a competitor of, or setting up a business in competition with, the target for a certain period and within a defined geographical region; and
- Non-solicitation and non-dealing which are designed to prevent the relevant party from soliciting the target's customers or suppliers and/or poaching key employees of the target for a specified period.
Enforceability
To be enforceable, restrictive covenants should be reasonable and protect a legitimate business interest. To determine the reasonableness of the restriction, the following are some of the factors that will be considered by the courts:
- Nature and scope of the activity being restricted - the covenant should be limited to the type of business the target is carrying out.
- Duration - in an employment context, any covenant of more than 12 months is likely to be considered unreasonable. In the context of acquisitions or investments, two to three years will generally be acceptable but this will depend on the nature of the business. Generally, the longer the restriction, the less likely the courts will find the restriction to be reasonable.
- Geographical reach - the restriction should only cover the geographical areas in which the target operates and/or the areas the target has clear plans to operate.
Case study: Literacy Capital Plc v Webb
An example of the court considering these factors is the case of Literacy Capital Plc v Webb [2024] EWHC 2026 (KB). This case involved the enforceability of restrictive covenants contained within an investment agreement and loan note instrument entered into by Vanessa Jane Webb (the "Defendant") and Literacy Capital Plc (the "Claimant") in relation to Mountain Healthcare Limited (the "Company").
The restrictive covenants prohibited the Defendant from trading in competition with the Company and all other businesses in the Company's group. The restrictions were in place for a maximum duration of 10 years and applied to the UK and Channel Islands.
The Claimant sought an interim injunction in order to enforce the restrictive covenants to stop the Defendant from engaging in competitive trading with the Company's subsidiaries.
Looking at each of the factors in turn it was held that:
- The scope of the business being restricted was too wide, going beyond the services which the Company delivered.
- The claimant could not justify the necessity for the duration of 10 years.
- The geographical scope being the UK and Channel Islands was too wide. There was no evidence to prove that the scope of the Company’s contracts went beyond Norfolk and Suffolk.
The High Court therefore refused to grant the interim injunction, finding that the covenants were void and unenforceable.
How can Brodies help?
If you would like more information about restrictive covenants in corporate transactions, please contact a member of the Corporate Team or your usual Brodies contact.
