Non-compete restrictions in shareholders' agreement upheld by Court of Appeal
In the recent case of Guest Services Worldwide Limited v David Shelmerdine, the Court of Appeal considered the proper construction of restrictive covenants included in a shareholders' agreement and whether those covenants were unenforceable because of their duration and/or their nature and extent. Overturning the High Court's decision, the Court of Appeal found that the covenants, including in particular the non-compete restriction, were binding, and that the 12 month duration of the covenants was "entirely reasonable".
Guest Services Worldwide (GSW) is in the business of producing maps for distribution to the guests of luxury hotels. The business was founded by Mr Shelmerdine. He sold the business in around 2011 and was retained first as an employee and then, in July 2015, as a consultant. The consultancy arrangements between GSW and Mr Shelmerdine were terminated in February 2019.
Mr Shelmerdine was also a shareholder of GSW and party to a shareholders' agreement (the Shareholders' Agreement). It was agreed that as a result of the termination of the consultancy arrangements Mr Shelmerdine was deemed to have served a transfer notice in respect of his shares, pursuant to GSW's Articles of Association. He did, however, remain a shareholder of GSW as at the date of the Court of Appeal hearing (December 2019).
The Shareholders' Agreement included various restrictive covenants (Restrictions), each of which applied to 'Employee Shareholders' and which were given by each Employee Shareholder to all other GSW shareholders, and to GSW itself. The Restrictions were to continue at any time when the relevant party was a shareholder in GSW and for 12 months after the party ceased to be a shareholder. 'Employee Shareholder' was defined in the Shareholders' Agreement as "any Shareholder who is also an employee, agent or director of the Company and those Shareholders who are Employee Shareholders as at the date of this Agreement". Mr Shelmerdine was identified in the Shareholders' Agreement as one of the Employee Shareholders.
Following the termination of Mr Shelmerdine's consultancy arrangements, GSW alleged that in breach of the Restrictions he had used a map produced for GSW to solicit business in Switzerland in March 2019, and had subsequently solicited business from the Ritz Carlton in Budapest and the Metropole in Monaco. High Court proceedings were brought against him on 1 April 2019 for an injunction restraining breach of the Restrictions.
Mr Shelmerdine argued that whilst he remained a shareholder of GSW, as soon as he ceased to be an agent of the company he ceased to be an Employee Shareholder and that the Restrictions therefore no longer applied to him. He also argued that, in any event, the Restrictions were unreasonably wide and an unenforceable restraint of trade. The High Court agreed on both counts.
GSW appealed to the Court of Appeal, on the basis that the High Court was:
- wrong to find that the Restrictions which purported to apply for 12 months following the relinquishment of shareholder status never came into effect, having disappeared at the same time that Mr Shelmerdine's consultancy arrangements ended (the Construction Issue); and
- wrong to find that the 12 month period of the Restrictions was longer than necessary to protect GSW's legitimate business interests (the Duration Issue).
The Court of Appeal
The Court of Appeal overturned the High Court on both issues. On the Construction Issue, the Court found that it was clear that the purpose of the Restrictions was to protect GSW, its goodwill and the value of its shares and that it would make "no commercial sense at all if the restrictions [in the shareholders' agreement] could be avoided altogether and with immediate effect, by terminating one's employment, agency or directorship". That would give the Restrictions no real meaning or effect. Accordingly, having considered the objective meaning of the Restrictions when read in their factual and commercial context, the Court of Appeal held that Mr Shelmerdine remained bound by the Restrictions (and, in particular, the non-compete clause) for as long as he remained a shareholder in GSW, and for 12 months thereafter.
This was despite Mr Shelmerdine's argument that this would mean that he could remain subject to the Restrictions for a potentially indefinite period, whilst he remained a shareholder of GSW before he could be bought out, if indeed he could be bought out at all. The Court of Appeal gave this argument short shrift, on the basis that (given the compulsory transfer provisions included in GSW's Articles of Association) in all likelihood the cessation of employment, agency or directorship and ceasing to be a shareholder would be co-terminous or, at least, there would be only a limited lapse of time between the cessation of employment and the disposal of the individual's shares.
With regard to the Duration Issue, the Court of Appeal noted that whilst all restrictions in restraint of trade are unenforceable unless they are reasonable, the courts should be "less vigilant" where restrictions are contained in a shareholders' agreement or similar agreement rather than in an employment contract. On this basis, the Court of Appeal did not accept that a period of 12 months was unreasonable. The Court noted in particular that:
- it was clear that GSW had a legitimate interest in seeking to prevent Employee Shareholders from competing with the business and soliciting clients;
- the Restrictions were contained in a shareholders' agreement, made between experienced commercial parties; and
- a period of restraint lasting 12 months was "entirely reasonable to protect that interest". This was the case even though the 12 month period did not start to run until the relevant party ceased to be a shareholder in GSW, rather than when that party ended his employment, agency or directorship with the company. The Court did not consider that the Restrictions should be declared to be unreasonable on the basis of the relatively unlikely possibility that there may be considerable delay in the process of relinquishing shares in GSW or the extreme and very unlikely possibility that a shareholder may be locked in indefinitely.
Restrictive covenants are commonly included in shareholder agreements and other commercial agreements. These include business and/or share sale agreements, partnership agreements, joint ventures and franchise agreements. They are a valuable means of protecting a party's interests and should continue to be used.
The Court of Appeal's decision in this case is a welcome reminder that the courts will be less vigilant in scrutinising restrictive covenants included in commercial agreements (as opposed to employment contracts) and are very willing to uphold such covenants. Nevertheless, parties should ensure that restrictive covenants in all agreements are very clearly drafted, including who specifically is covered by them and when they will be triggered. As always, clarity is key.