Restrictive covenants may not seem the most important consideration when welcoming enthusiastic new shareholder to the business or when managing an amicable exit.
However, what happens when a departing shareholder seeks to set up a competing business, solicit key clients, or, potentially, damage your company's reputation? Things change and it is important to ensure your business is protected in all such scenarios. Restrictive covenants are a mechanism by which this can be achieved and are a vital part of any shareholders' agreement.
What is a restrictive covenant?
In simple terms, a restrictive covenant is a contractual promise not to do something.
Restrictive covenants are an important protective mechanism. however, courts will not enforce provisions that are excessively broad or unreasonable. The scope, duration and geographical reach of these covenants will often depend on your industry and the role the shareholder played in your organisation and will need to be accurately drafted.
Common types
Here are a few examples of restrictive covenants you may want to consider using to protect your company's interests:
- Non-compete clause: prevents a party (e.g. an exiting shareholder) from engaging in a competing business.
- Non-solicitation clause: prevents an exiting party from approaching or enticing away clients or customers.
- Confidentiality clause: prevents disclosure or misuse of sensitive information.
- Non-disparagement clause: prevents the departing party from making negative statements about the company.
Again, many of these clauses may not seem necessary at the outset, but things change, and they are sensible to include regardless of how amicable relations may be at the time.
What happens if they don't comply?
Where a shareholder does not comply with a restrictive covenant, they have committed a breach of contract. To resolve this, notifying the shareholder of their breach and demanding compliance may be sufficient. Otherwise, breaches of contract can be escalated to our Dispute Resolution team who can assist in resolving the breach.
Importantly, courts are generally more willing to enforce restrictive covenants against shareholders than in employment contracts, due to the more equal bargaining power involved between shareholders as opposed to between employer and employee.
How can we help?
Restrictive covenants are only effective if they are properly drafted from the outset. Overly broad provisions risk being unenforceable, whilst inadequate protections leave your business vulnerable. For example, a correct and accurate definition of the company's business is crucial in ensuring the non-compete clause remains enforceable.
Our Corporate and Commercial team has extensive experience advising businesses across all sectors on restrictive covenants in shareholders' agreements. We ensure your provisions are tailored to your specific business and robust enough to provide meaningful protection.
Whether you are bringing in new shareholders, managing an exit, or reviewing existing agreements, we can help you achieve the right protection for your company.
