A brush with the law?
Trainee Solicitor, Emma Armstrong, explains restrictive covenants in share purchase agreements, as illustrated in a case involving a hairdressing business.
When selling a business, the buyer will normally wish to impose restrictive covenants on the seller, to ensure the seller does not compete with the business in the future. The buyer has usually paid a sum of money for the ‘goodwill’ of the business, and therefore the buyer should have a period of time to run the business without the threat of competition from the seller.
Restrictive covenants are only enforceable by a buyer if they are reasonable and go no further than is necessary to protect the buyer’s legitimate business interests. The High Court recently considered whether restrictive covenants given by the seller of a hairdressing business were enforceable by the buyer. As the judge observed, hairdressers have been a rich source of jurisprudence in this area.
In 2008, Ms Gibson-Forbes began running her hairdressing business from two salons in Windsor. After a number of successful years, a company called Rush Hair agreed to buy the business and there were two restrictive covenants contained in the share purchase agreement. These stipulated that within two years of completion Ms Gibson-Forbes could not:
- Canvass, solicit, entice or employ certain stylists; or
- Be directly or indirectly engaged or interested in any competing business within a two mile radius of either salon.
Shortly following the sale, Ms Gibson-Forbes opened a new salon in Windsor through a new company, S.J Forbes Ltd, of which she was a director and shareholder. The company engaged two of her former employees as stylists in the new salon, and Ms Gibson-Forbes argued that the restrictive covenants did not apply to the conduct of her new company as opposed to her own conduct.
Considerations of the Court
In considering whether the covenants were enforceable, the Court considered a range of factors as follows:
- The covenants should be construed in a commercially sensible manner, which meant that they applied to Ms Gibson-Forbes acting on her own behalf or as an agent for her company; therefore she was not able to use S.J Forbes Ltd as a vehicle to bypass the restrictions.
- Rush Hair paid £50,000 for the goodwill of the salons; therefore it was entitled to protection. In addition, it had a legitimate interest in ensuring that the stylists remained. If either of the stylists left the business this could diminish the goodwill.
- The two year period was held to be reasonable; where a seller is paid a significant sum for goodwill the courts are more likely to enforce lengthy periods of restriction.
- The two miles radius was held to be reasonable. Rush Hair was entitled to take the view that if Ms Gibson-Forbes relocated to another part of Windsor, this would result in a loss of customers from Rush Hair’s newly acquired salons.
The Court held that Ms Gibson-Forbes had breached both covenants.
This case is a useful reminder that well drafted restrictive covenants will be enforced by the Court, where a buyer has paid for the goodwill of the business, and is entitled to a degree of protection from the activities of the seller.
However, the main point to note is that the Court was not prepared to allow the seller to escape her obligations by operating through a limited company. In this instance, the Court was prepared to “pierce the veil” of incorporation, and effectively treat the company and the seller as one and the same person.
The case is likely to prove good news for buyers of businesses, and bad news for sellers, or at least those sellers who are prepared to employ the “tricks of the trade” to try and avoid their contractual commitments. The message is that if you take the money you have to keep your promises, and that is no bad thing in business.
If you would like more information on restrictive covenants in share purchase agreements please contact Emma Armstrong at firstname.lastname@example.org.
About the author
Emma is a Trainee Solicitor in the firm's Corporate team.