Enforcing non-compete restrictive covenants in business sale agreements

Why is Ivy Technology v Martin of interest and what happened in the case?

This decision [1] provides a clear and helpful reminder of the principles the courts will apply when considering the enforceability of a non-compete restrictive covenant in a business sale agreement.

One aspect of the case concerned the alleged breach of this type of covenant in a sale and purchase agreement (SPA). The defendant was a shareholder of the companies purchased by the claimant under the SPA and was a party to the SPA. The court agreed that some of the defendant’s objections to the wording of the covenant raised serious concerns.

Among other things, the clause in question prohibited solicitation or hiring of any employee or consultant of the companies and/or the claimant purchaser, at any date during the currency of the covenant. The defendant argued that there was no limitation on the seniority of those employees or consultants, nor any requirement that they held any confidential information. The employee or consultant could have been recruited after the date of the SPA, and after termination of the defendant’s relationship with the claimant. The defendant need not even have known that the individual was an employee or consultant of the claimant to fall foul of the prohibition.

The defendant also objected to the five-year period of the restriction and the fact that it applied to every element of the clause. In respect of the length of protection required, the claimant made no attempt to distinguish between less invasive elements such as non-interference with clients and non-poaching of employees and the more invasive bare and broad non-compete provision.

The court was not persuaded that the claimant had discharged the burden of showing that the clause was reasonable. A covenant lasting as long as five years was a serious imposition requiring specific justification. The same applied to the potential application of the clause to employees or consultants however insignificant their role and even if they joined the business after the sale.

The key message? While it was possible to save the covenant by more radical ‘blue-pencilling’ than had been suggested by the claimant, it was not the court’s function to seek to rescue a covenant, or parts of it, in ways which had not been put forward by the party relying on the clause and which had not been the subject of argument (still less of evidence). The ‘blue pencil test’ is where an unenforceable provision can be removed without needing to add to or modify the rest of the wording.

What principles will the court apply?

The court highlighted the following from case law:

• Three questions have to be decided when considering the enforceability of this type of covenant. First, the court must decide what the covenant means when properly construed. Secondly, the court should consider whether the party relying on the covenant has shown on the evidence that it has legitimate business interests requiring protection. Thirdly, once the existence of a legitimate protectable interest has been established, the covenant must be shown to be no wider than is reasonably necessary for the protection of those interests.
• If a covenant goes further than is reasonably necessary to protect a legitimate business interest, even in a business sale agreement, it is void and will not be enforced. Specifically in relation to non-poaching covenants, the law is wary of any restriction on a worker’s capacity to earn their living as they choose, even if the restriction is imposed indirectly (on a potential employer or recruiter).
• The question of reasonableness is to be assessed as at the date of the agreement, including a reasonable assessment of the future.
• For a restriction to be reasonable, it must afford no more than adequate protection to the party in whose favour it is imposed.
• The law distinguishes between covenants in employment contracts and covenants in business sale agreements. There is more freedom of contract between buyer and seller than between master and servant, because it is in the public interest that the seller should be able to achieve a high price for what they have to sell. The amount of consideration may enter into the question of the reasonableness of the covenant.
• The court should be slow to strike down clauses freely negotiated between parties of equal bargaining power, recognising that parties are often the best judges of what is reasonable as between themselves. However, the court’s deference to the parties is not absolute. The mere fact that parties of equal bargaining power have reached agreement does not preclude the court from holding the agreement bad where the restrictions are clearly unreasonable in the interests of the parties.
• Industry practice as to restrictive covenants is of little assistance: the court’s task is to determine reasonableness for itself.
• There is no fixed rule requiring witness evidence to be produced in support of the reasonableness of a restriction: the transaction documents themselves and/or other contemporary documents before the court may provide sufficient basis on which to conclude that a legitimate interest existed and that a particular restriction was reasonable in the circumstances.
• In considering when an offending/unenforceable part of a covenant can be severed from the rest, the two key questions are: (i) is the unenforceable provision capable of being removed without needing to add to or modify the rest of the wording (the ‘blue pencil test’); and (ii) would removing the provision generate any major change in the overall effect of the restrictions in the contract? If the answers to these questions are respectively “yes” and “no”, then the covenant can be severed and the offending words deleted.

How we can help

Our team of specialist lawyers is experienced in successfully advising clients throughout the entire process of business protection from drafting restrictive covenants and obtaining interim injunctions through to enforcing injunctions and taking matters to trial. Our lawyers understand the process and recognise that each situation has its own specific circumstances and commercial realities. They have the experience to be able to discuss the various options with you and the likely outcomes.

Please get in touch with Gwendoline, Nick Jack or Simon if you need any advice or assistance.

Have you seen…

…our recent webinars as part of our Restrictive Covenant and Confidential Information series?

Watch out for…

…our upcoming webinar (scheduled to take place later this year) which forms the next part of this series.

Details to follow but please feel free to email us to register your interest.

[1] Ivy Technology Ltd v Martin & Anor [2022] EWHC 1218 (Comm)