The inclusion of non-compete restrictions in a shareholders’ agreement or an investment agreement can be a useful technique for companies to employ to ensure that a shareholder or investor cannot, either during their time holding shares in the company, or, for a specified period of time after, be involved in any business that competes with the company.
As a general rule, a covenant of this kind, otherwise known as a restrictive covenant or a restraint of trade provision, is void unless the party wishing to rely on it can satisfy the Court that the covenant does not go further than reasonably necessary to protect a business’s legitimate business interests. A useful illustration of this principle recently emerged in the case of Sparta Global Limited v Hayes [2024], where the High Court issued a significant Judgement to an interim application made by Sparta Global Limited (“Sparta”) for an injunction against its former employee, Mr Hayes:
- Mr Hayes was employed by Sparta in October 2020 under a contract of employment that contained restrictive covenants, namely a six month non-compete restriction that prevented him from working for a competitor in the same role he was performing at Sparta.
- A short time after the commencement of his employment in March 2021, Mr Hayes also signed a deed of adherence under which he agreed to be bound by the terms of investment agreement, inclusive of a non-compete restriction preventing him from working for a competitor in any capacity for 12 months following the termination of his employment contract.
- Mr Hayes subsequently resigned with the intention of starting employment with a competitor of Sparta, Kubrick Group Limited, and Sparta sought an interim injunction to prohibit Hayes from working for the competitor specially on the basis of the restrictions within the investment agreement (as opposed to those in the contract of employment).
- The High Court were required to determine at the early stage of the interim hearing whether the restrictive covenant within the investment agreement amounted to an unlawful restraint of trade and as such, whether the clause was unenforceable.
- Sparta were able to establish a legitimate business interest relatively easily, given that Mr Hayes had been privy to confidential and commercially sensitive information, that Sparta considered would be of great value to its competitors and described as “a pipeline of future work – gold dust”.
- The High Court then considered the nature of the agreement, specifically whether this was an agreement of a commercial nature, agreed upon with equal bargaining power, or whether the balance of bargaining power laid with the company. The Court considered that, because the parties did not negotiate the investment agreement and that it was not disputed that Mr Hayes was put under pressure to sign the deed of adherence to the investment agreement, nor that Mr Hayes was not provided with a copy of the investment agreement until after the termination of his employment, it was closer in nature to a contract of employment, particularly in light of his modest shareholding of 0.35%.
- A key factor in the High Court’s decision was that Mr Hayes had, prior to entering into the investment agreement, signed the contract of employment containing less onerous restrictions. Sparta had failed to sufficiently explain to the Court why the more onerous restrictions issued only a few months later were reasonably necessary.
8. Other factors such as the fact that:
- A lack of evidence to demonstrate a disclosure of confidential information by Mr Hayes
- Mr Hayes’s new role was of a different nature to his previous role, and not a breach of the restrictions in his contract of employment
- The scope of the restriction on competition within the investment agreement extends to the whole of Sparta’s wider group, regardless of whether Mr Hayes was involved or knew anything about other areas of the business
- Sparta were able to dismiss Mr Hayes on one week’s notice at the time that he became subject to the 12 month restrictions under the investment agreement, all played a part in the Court’s decision
- Ultimately, the Court refused to grant the interim injunction.
It is worth noting that this Judgment is not a final finding of fact, it relates only to the interim application for an injunction and is based on limited disclosure and evidence. The outcome of the case does however require companies to think twice before pursuing an interim injunction as a remedy for breach of a restrictive covenant, and to only do so where they can demonstrate on the facts that both the restrictions imposed, and the interim injunction, are required.
As a representative of a business, where you wish to impose updated, more onerous restrictions, via a new contractual document, you should ensure that you have the justification to do so beforehand, should you be required to demonstrate to the Court why the restrictions are reasonably necessary.
The case law has established that the following requirements must be satisfied for a restraint to be valid under Auckland law:
- The existence of a valid interest that the company imposing the restraint seeks to protect
- The restraint is no wider than is reasonable to protect that interest
- The restraint must not be contrary to the public interest
Whilst the bulk of the case law concerns restrictive covenants in the context of employment, and, to a lesser extent, business sales, the principles apply to other contractual documents such as shareholders’ agreement and investment agreements.
The Courts and law makers have historically been reluctant to draw a clear line in the sand between what is in restraint of trade and what is not. What is considered reasonable, and therefore enforceable, will depend on the facts and circumstances of each individual case. Sparta Global Limited v Hayes however demonstrates that, in assessing reasonableness, the Courts will look at:
- The balance of bargaining power between the business looking to enforce the restrictions and the restricted party
- Whether the parties negotiated the relevant document, in particular the restrictive covenants
- There restrictions are updated or substituted with more onerous provision, the justification for this
If you require any advice or assistance in relation to non-compete restrictions in shareholders’ agreement and investment agreements, please contacts our Corporate team by email or phone on 0113 207 0000.
