18.Jan.2019

Non-compete restrictions for employee shareholders: lessons from the Commercial Court

Employers will often include restrictive covenants in employment contracts to ensure their business interests are protected when an employee leaves.

Where the employee is also a shareholder, there may be similar restrictions contained in a separate shareholder’s agreement.

The Commercial Court recently considered an application by Ideal Standard International NV (Ideal Standard) for an interim injunction to restrain an employee shareholder from breaching a non-compete clause in a shareholder’s agreement, which the employee argued had been waived in a settlement agreement. The Court’s decision raises some interesting points for employers and employment lawyers alike to consider.

Background - Ideal Standard International SA v Herbert

Mr Herbert was employed by Ideal Standard for around 20 years. He was a senior executive, most recently holding the role of Vice President of Products and Innovation, and was a member of the company’s Executive Management Team.

As part of a long-term incentive scheme for senior employees, Mr Herbert entered into a Shareholders Agreement. The Shareholders Agreement contained a non-compete clause which purported to prevent Mr Herbert, following termination of employment, from competing with Ideal Standard and its group companies for a period of 18 months in any jurisdiction in which they both operated. The Shareholder Agreement stated that any waiver or election not to enforce any right under that Agreement must be in writing and signed by, or on behalf of, the person granting it.

Mr Herbert was dismissed and subsequently entered into a settlement agreement with Ideal Standard. Shortly thereafter, Mr Herbert took up employment with a competitor, giving rise to the application for interim injunction. Mr Herbert challenged the application on the basis that (i) the Settlement Agreement had waived the non-compete restrictions in the Shareholder Agreement; and (ii) that the non-compete restriction was too broad and therefore unenforceable.

Non-compete waived by settlement agreement?

In seeking to convince the Commercial Court that the non-compete restriction had been waived, Mr Herbert pointed to the terms of the Settlement Agreement, which stated that the agreement was “intended to settle outstanding differences” between the employee and any company/group company; and also stated that the parties “declare[d] expressly that none of them will have any obligations vis-à-vis the other Party”.

He submitted that this waived the non-compete, and that Ideal Standard had signed the Settlement Agreement for, and on behalf of, all group companies.

The Judge rejected this, holding that:

  • There was no reference in the Settlement Agreement to the Shareholder Agreement.
  • The Shareholder Agreement was clear that any waiver or election not to enforce any right must be in writing and signed by the person granting the waiver. The Settlement Agreement did not achieve this.

Can longer and broader restrictions be justified in an employee shareholder context?

Ideal Standard sought to remind the Court that it is generally easier to enforce non-compete clauses contained in shareholder agreements than in the ordinary employee context. The Judge rejected the idea that this was simply a matter of categorisation: with non-compete clauses in employment agreements held to one standard, and non-compete clauses in shareholder agreements held to another. He instead preferred to see them as points on a spectrum. The enforcement of a restrictive covenant in any context should be judged according to same legal principles (legitimate interest, necessity and reasonableness). The Judge noted that the fact Mr Herbert was a shareholder did not change the test, but the particular circumstances in question would of course be relevant in establishing whether the relevant tests were met.

Being ‘interested’ in a business

The non-compete restriction in the Shareholders Agreement prevented Mr Herbert from having ‘an interest’ in a competing business. He argued that the non-compete was too wide, and therefore unenforceable, because there was no carve-out for passive shareholdings (e.g. permission to hold a minor shareholding - usually up to 5% - in another company). He referred to a recent Court of Appeal case (Egon Zehnder Ltd v Tillman) which had held that the phrase ‘interested in’ could be interpreted widely enough to include a holding of one share in a publicly quoted company, which meant the restriction was too wide and therefore not enforceable. However, as the Egon case was under appeal, the Judge did not feel bound to follow it and felt that the issue was “not a closed book”.

In this case, the Judge was satisfied by other factors in favour of interim injunction, and the application was granted.

Key lessons

This decision serves as an interesting reminder:

  • to individuals, employers and employment lawyers to consider the intended impact of a settlement agreement on obligations arising outside the employment contract, and ensure that these are expressly provided for;
  • not to assume that restrictive covenants in shareholder agreements will automatically be held to a lower standard of enforceability, but to ensure they are appropriate in each case; and
  • that the law in this area is ever-changing so we continue to watch this space for further developments.

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