The recent Court of Appeal decision in Guest Services Worldwide Limited (GSW) v Shelmerdine, has provided clarity in respect of the enforceability of restrictive covenants in shareholders' agreements
Mr Shelmerdine was a consultant and a shareholder of GSW and a party to a shareholders' agreement (the Shareholders' Agreement).
The Shareholders' Agreement contained various non-competition, non-dealing and non-solicitation restrictions to "Employee Shareholders" (the Covenants). Employee Shareholders were defined as "any shareholder who is also an employee, agent or director of the Company", and therefore included Mr Shelmerdine. The Covenants applied while Mr Shelmerdine was a shareholder and for 12 months after he ceased to be.
Mr Shelmerdine's consultancy ended in February 2019. Following allegations that Mr Shelmerdine had been using GSW's confidential information to solicit customers, GSW sought to enforce the Covenants in the Shareholders' Agreement by seeking injunctive relief.
High Court – decision at first instance
Mr Shelmerdine argued that when his consultancy terminated, the definition of "Employee Shareholder" was no longer applicable to him and that as a consequence the Covenants no longer applied to him. The High Court accepted this argument.
The High Court also accepted Mr Shelmerdine's argument that, as it was potentially possible for him to remain a shareholder indefinitely, if he was unable to sell his shares, the Covenants had been drafted too widely and were therefore unenforceable.
GSW appealed the High Court's decision on the grounds that the Judge:
- misconstrued the provisions of the Shareholders' Agreement (the Construction Issue); and
- erred in concluding that the Covenants extended further than reasonably necessary to protect GSW's legitimate business interests (the Duration Issue).
Court of Appeal
The Court of Appeal allowed GSW's appeal on both grounds.
The Construction Issue
In respect of the Construction Issue, the Court found in GSW's favour that:
- the Covenants needed to be considered in the wider context of the Shareholder's Agreement and GSW's Articles of Association;
- the rights and obligations in the Shareholders' Agreement had been drafted to protect GSW;
- the compulsory transfer provisions in the Articles, clearly envisaged that employees would only remain shareholders for a relatively short period once their employment, agency or directorship, with GSW terminated; and
- it would not make commercial sense, nor would the Covenants have any force, were Mr Shelmerdine able to avoid the Covenants by simply terminating his employment while continuing to be a shareholder.
It was consequently held that an Employee Shareholder (including Mr Shelmerdine) would be bound be the Covenants for so long as they remained a shareholder and for a further 12 months after.
The Duration Issue
In respect of the Duration Issue, the Court again found in GSW's favour finding that:
GSW had a legitimate interest in seeking to prevent Employee Shareholders from competing with the business and soliciting clients, especially given the particular nature of the business and the knowledge that such individuals are likely to have obtained;
- the Shareholders' Agreement was made between commercial parties;
- a period of 12 months was entirely reasonable to protect the legitimate interest;
- although the 12 month period only runs from the date on which the individual ceased to be a shareholder (rather than the termination of his employment, agency or directorship), in all likelihood, such events would likely happen at the same time or within a short period of time of one another; and
- the Covenants should not be deemed unreasonable on the basis of the relatively unlikely possibility that there may be considerable delay or the extreme and very unlikely possibility that a shareholder may be locked in indefinitely.
The appeal was therefore upheld and Mr Shelmerdine was held to be bound by the nature and duration of the Covenants.
In light of the Court's decision Employers should ensure that their Employment Contracts and Shareholder Agreements contain restrictive covenants to protect their business. To be enforceable, all restrictive covenants must be drafted clearly, with no doubt as to who they apply to and go no further than reasonably necessary to protect the employer's legitimate interests.
Addleshaw Goddard is recognised as the market-leading Business Protection Practice. Our team’s work focuses on advising organisations on team moves and helping employers to manage the risks stemming from employees and third parties who pose a threat to their legitimate interests, by taking action to enforce the employer’s rights and protect confidential information ranging from securing undertakings or obtaining injunctive relief, to pursuing claims for damages/loss of profits.