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How long is too long? The duration of restrictive covenants in business company sales

The High Court has held that a restrictive covenant in a share purchase agreement which (in the absence of breach) would last for a minimum of eight and a half years was not an unreasonable restraint of trade (Cavendish Square Holdings BV and another v El Makdessi 2012 EWHC 3582).

Background

A purchaser of a business or a company will wish to prevent a vendor from acting after completion of the sale in such a way as to diminish the value of the business or company acquired. A purchaser will seek express covenants from a vendor that it will not for a specified period solicit customers, suppliers or employees of the business or company or compete generally with the business or company for a specified period within a specified area.

It is well known that in order for such covenants to be enforceable, they must be reasonable in the interests of the parties, be in the public interest and go no further than is necessary to protect the purchaser's legitimate business interests. In assessing what is reasonable, the length, geographical area and overall scope of the covenant need to be considered. Further, it is for the party seeking to enforce the covenant to show that it is reasonable (although the burden is not as heavy as it is with employment restrictive covenants).

Under the 2004 European Commission Guidelines, a three-year non-compete period will generally be acceptable where both goodwill and know-how have been acquired and a two-year period where only goodwill is acquired. However, longer durations may still be justified in a limited range of circumstances.

The key issue for the court is to determine whether or not it is satisfied that the covenant goes no further than is necessary to protect the interest of the purchaser.

Facts

The purchaser entered into an agreement to purchase shares in the target company. The consideration included a substantial amount for goodwill. A number of restrictive covenants were contained within the agreement, including that the vendor would not carry on or be engaged, concerned or interested in competition with the group in certain restricted activities. The period of restraint was for 24 months after the occurrence of the latest of a number of events. Given the terms of the agreement, this would mean that the vendor would need to wait for a minimum of eight and a half years from the date of the agreement to be free of the covenants.

The vendor admitted acts which would amount to a breach of the covenant but contended that the covenant was an unreasonable restraint of trade and therefore unenforceable.

Decision

The High Court held that the covenant was not an unreasonable restraint of trade. The reasons given for the decision include that the agreement (including the provisions regarding the length of the covenants) was fully negotiated "on a level playing field" between the parties with experienced legal advisors acting on both sides; the goodwill acquired and paid for was substantial; the purchaser was happy to pay the consideration on the condition that it enjoyed the benefit of the covenants; and the period of eight and half years was to protect the purchaser's interest from competition from the vendor who was continuing to act as an a non-executive director and chairman of the company acquired.

Comment

This case shows that the courts will not hold a restrictive covenant as unenforceable provided that it is satisfied that it goes no further than is reasonable in the circumstances. As the judge noted, there is no reported case in which a restrictive covenant otherwise reasonable was held to be unenforceable because it was too long.

However, this judgement should not encourage purchasers to insist on lengthy restrictive covenants unnecessarily as the decision does not depart from the well-known principal that for a restrictive covenant to be enforceable it must be reasonable having regard to the protection of a legitimate interest.

 

This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.