We are selling a 25% interest in our business to a financial investor. If they were to subsequently sell their 25% we want a restraint clause that forbids them from investing in a direct competitor of ours, so that they don't take the knowledge of our business, and utilise this knowledge with the competitor. We wanted a restraint clause of 5 years. They have come back to us with 2 years on the grounds that a 2 year restraint clause will be enforceable under UK law and any longer period won't be. Are they correct?
System of Law: England-and-Wales
Everyone is aware on problems with the length of restraint clauses under employment law but less certain about the length of restraint clauses in corporate law
Hi, Thank you for your question and welcome to Just Answer. Restrictive Covenants (or Restraint Clauses) are effectively a restraint on trade and therefore are contrary to EU Law and the free trade provisions. In order for a Restrictive Covenant to be enforceable it has to be the bare minimum of what is required. I have never seen a restrictive covenant of 5 years that is enforceable two years is normally the absolute maximum and even then you will be hard pushed to enforce it. You would have to prove that in your line of business information (i.e customer lists, know how etc) is so sensitive that even in two years time it would still be a valuable to your business. In business two years is a long time and you would expect if some has been away from a business for two years they would be less of threat with the confidential information they previously had access to.
Consider the following to get the most enforceability out of your restrictive covenant:
- Is it limited to the Geographical area within which you trade?
- Do you refer to specific, key employee customers etc?
- Do you refer to specific bits of confidential information - i.e value data bases etc?
The more specific you are the easier it will be to enforce.
Just to be clear is there anything so unusual that you could actually justify a five year restraint - i.e are you doing something so cutting edge that it needs to protected?
Also are these restrictive covenants being contained in a shareholders agreement?
I look forward to hearing from you.
Yes, limited to the geographical area in which we trade
No, no reference to key employees, customers, we just don't want them to invest in our direct competition for a period
Hi, Thank you. You will need to include where you can specific key personnel and customer contacts. Also make sure there is a clear definition of (a) Confidential Information, (b) Restricted Persons/Customers and (c) Restricted Employees.
No, we do not refer to specific bits of confidential information
No there is nothing so cutting edge that it needs to be protected
Also you will want to consider having a restriction on who they can sell there shares to. Ideally you would want to have first refusal on their shares should they decide to sell. Also if they do sell to a third party you would want the third party to be subject to the same restrictive convenants, this would be done by insisting they sign up to a deed of adherence.
Yes, the restrictive covenants will be contained in a shareholders agreement
Thank you - I think then for this purpose 18 months to two years from the date that they cease to be a shareholder and/or director (if applicable) should be sufficient. You are never going to be able to stop some one from starting a competing business indefinitely - that concept is just contrary to public policy.
Can I be of any further assistance? I would be happy to talk through the elements of the Shareholders Agreement? Kind regards AJ
So I understand the more specific we can be the more likely we can enforce the restrictive covenant. but the main question is can a restrictive covenant be for 5 years (bearing in mind there is nothing cutting edge) because the investor is telling us 5 years no matter what won't be enforceable and hence there is only any point in having a 2 year restrictive clause in any case. I suppose one question is if someone knowingly agrees to 5 years then why would a UK court say that is not allowed?
I think you have answered my last question, you believe that unless something is really cutting edge a UK court would only accept 18 to 24 months. Is that correct?
Hi, Yes that is correct. As I have never seen a Court enforce a restrictive covenant of more than 2 years. To have one for 5 years, you would have to create a new legal principle through a set of facts that were so unique the only way the business could be protected would be through a five restrictive covenant. On the basis that your business is seeking to protect normal information for example customer lists and key employees under its restrictive covenant clauses, and considering that you have limited to a geographical area and this is not the investors sole line of business, 18-24 months would probably be enforceable, but you wont get away with any longer.
Kind regards AJ
P.S Sorry for the typos, this is real time and I am on an I Pad.
I hope this has been of assistance.
Tks, that was helpful
Thank you very much. Please do not hesitate to contact me if you would like to discuss restrictive covenants or shareholder agreements further. If you were completely satisfied I would be most grateful if you would give me some positive feedback when accepting my answer. Kind regards AJ
LLB, LPC, DELF
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