The law is generally wary of restrictive covenants, as they tend to be contrary to public policy in that they restrict parties from exercising their general freedoms, often to do the only thing they are good at. As such, they can always be challenged as to whether they are reasonable, and the court will take into account all of the relevant circumstances of each case. Of particular importance will be the duration of the restrictive covenant post-termination of the contract, and the geographical scope of it. Clearly the longer the clause lasts, and the wider the geographical area it covers, the more likely it is to be challengeable as unreasonable. Generally, the courts have been more accepting of these clauses in commercial agreements as opposed to employment contracts, especially when the business in question has a legitimate and reasonable basis for the inclusion of such a clause.
Under the doctrine of restraint of trade, any contractual term which purports to restrict an individual's freedom to work for others or carry out his trade or business is void and unenforceable, unless the imposing party can show that it has a legitimate proprietary interest that requires protection and the protection sought is no more than is reasonable, having regard to the parties' and the public's interest. Legitimate business interests can include:
- Trade secrets and confidential information
- Trade or customer connections.
- Stability of the workforce.
In a recent case in the High Court (HC) decided that clauses which attempted to prevent a defendant (D) from trading in competition with the claimant's (C) subsidiaries were void and unenforceable.
In this case C had acquired D's 25% shareholding in a company (the Company), the consideration given was partly in cash and partly by way of a deferred loan. In 2021, D resigned from the Company and renegotiated the share sale, and at this point parties entering into a new investment agreement and loan note agreement. There were restrictive covenants in the relevant contract which sought to prevent D from competing with the businesses of any of C's subsidiaries within the UK within:
A. 12 months of D ceasing to be director or employee of all such subsidiaries; and
B. The period commencing when D became a loan note holder and ending 12 months after she ceased to be such (potentially 10 years, after the longstop redemption date was renegotiated to 2030).
Whilst technically this case hadn’t reached a final hearing, unusually the HC still concluded that on the facts of the case, there was no real arguable issue about the covenants' validity - they were void and unenforceable. The HC felt C had not, and would not be able to raise any arguable case that they were unaffected by restraint of trade law or issues with regard to what is reasonable both in terms of scope and duration. The issues arose from D's status as an employee, and as a founder, grower and vendor of the company, and therefore were subject restraint of trade law. Furthermore they were drafted so widely and for such a long period that they were clearly unenforceable at common law and breached public policy against restraint of trade.
The HC was of the opinion that C had failed to justify why a 10-year covenant was necessary, this far exceeding the duration allowed in previous ex-employee and sale of business cases. C also failed provide evidence justifying the nationwide scope of covenant other than simply asserting that they had an ambition to go nationwide ambition. The covenants went beyond any legitimate protectable interest, and C's subsidiaries undertook various unrelated activities. The HC felt that to protect these other businesses in this way made no legitimate sense, as D had no particular experience in those fields.
Whilst all cases are decided on their own facts, this is a good example of where by drafting a restrictive covenant too widely, either in terms of duration and/or geographical scope is ineffective and can lead to the clause not being worth the paper it is written on. It goes without saying that it’s far better to draft a covenant that is less onerous but is reasonable and therefore valid and enforceable.