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Going no further than reasonably necessary - the reasonableness of non-compete covenants in shareholder and service agreements

In the recent case of Law by Design Ltd v Ali, the High Court reviewed two post-termination non-compete covenants: one contained within a service agreement (“SA”), and one contained within a shareholders agreement (“SHA”). The Court found that only one of the covenants was enforceable. 

The Law:

For a post-termination restrictive covenant to be enforceable, the covenant must:

  • protect a legitimate interest of the employer, for example, an employer’s customers;
  • be a reasonable restraint;
  • not be for the sole reason of preventing competition; and
  • be no wider than necessary.

The Facts:

In 2013, the Defendant (Ms Ali) joined the Claimant’s business, a law firm called Law by Design (“LBD”). In 2015, the Defendant was issued with a 3% stake in LBD, regulated by a SHA. Several years later, the Defendant was promoted to a director, acquiring further responsibilities conferred by a SA. In 2021, the Defendant resigned to work for a competitor. 

Both the SA and the SHA contained restrictive covenants restricting the ability of the Defendant to compete with LBD. In the SHA, the non-competition covenant prohibited the Defendant from competing directly or indirectly with the firm’s business for a period of 12 months post-termination. In the SA, the post-termination restrictions prohibited the Defendant from competing with those parts of the firm with which the Defendant was involved to a material extent in the 12 months before termination.

The Claimant sought an undertaking from the Defendant that she would comply with the covenants contained within both agreements. The Defendant refused. The Claimant sought injunctive relief the aim of which, if granted, would be for the court to enforce compliance with the two sets of covenants.

The Decision:

The High Court found that the SA covenant was no wider than necessary and ought to be enforced by way of injunctive relief as it was limited to the parts of LBD’s business with which the Defendant was materially involved .

The High Court, however, found that the SHA covenant was too wide. In the Judgment, the High Court held that the covenant covered areas of the business that the Defendant was not involved with, and therefore extended beyond what was reasonably necessary for the protection of the firm’s legitimate business interests.

Our Comment:

Restraint of trade provisions such as restrictive covenants are policed very strictly by the courts as the judiciary appear unwilling to enforce contractual provisions which unreasonably restrict the ability of an individual to work or contribute to the business economy. If such strict policing of these types of provisions was not undertaken it would be easy to envisage a scenario whereby employees or shareholders were unreasonably restricted from carrying out business elsewhere to their own personal detriment following termination of their contracts. There is of course a balancing act to be undertaken by the courts however, as although covenants of this nature are strictly policed, that is not to say that legitimate business interests of companies do not equally need to be protected alongside the interests of departing employees. It is therefore important for all businesses seeking to rely on the operation of a restrictive covenant to ensure that it is drafted concisely and reasonably so as to go no further than strictly necessary to protect legitimate business interests. As the case discussed in this article shows, a covenant that has been drafted too widely  without intricate consideration of the interests it is aiming to protect runs the risk of being declared void, which could in turn leave a business exposed.

For more information on this article, please contact our Employment team.

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