Welcome to MJ Hudson’s monthly On Target, where you’ll find useful tips and insights to ease you through your M&A transactions.
This month we focus on non-compete covenants in management employment agreements and the common pitfalls associated with them.
A key focus in a buyer’s legal due diligence for the acquisition of a business will be the review of the employment (aka service) agreements of the target’s key directors and managers.
A buyer will want to ensure that, if a manager leaves the business, the relevant agreement prohibits that individual from, among other things, competing with the target’s business, unfairly dealing with its suppliers and customers, and poaching its employees. The relevant provisions – ‘restrictive covenants’ – apply for a defined period after the individual ceases to be employed in the business. If the existing restrictive covenants are inadequate, a buyer should seek to agree new agreements, or amendments to the old service agreements, with effect from completion.
Of these restrictive covenants, the non-compete provision (which is the focus of this article) is often seen as the most critical. However it is also the most restrictive for the employee, and so may prove the most difficult to enforce.
The starting point in the UK is that restrictive covenants are void as a matter of public policy because they amount to a restraint of trade. It follows that, for these covenants to be enforceable, they must go no further than is reasonably necessary to protect the relevant business’s legitimate interests.
Key drafting factors that will shape whether such a covenant is enforceable include:
An English court will generally not rewrite a restrictive covenant (or contract generally) because that would involve imposing its own view of the appropriate commercial terms on the parties. An English court might be willing to strike out some aspects of the covenant if doing so would not affect the operation or effectiveness of other provisions (what is known as the “blue pencil” test), and if such striking out is anticipated or even intended by the parties.
In order to encourage a court to do this, a “severability” clause is often included, stating that any part of the restrictive covenant that is found to be void should fall away without impact on the remaining provisions. Alternatively, the severability clause might suggest that the offending aspects should be considered as automatically amended in whatever way would make them enforceable. While this is clearly less drastic than striking out, it also requires significant court intervention which might not be forthcoming (see comment above).
As a result it is best to focus on drafting your non-compete in a way that is enforceable from day 1.
Yes, the same factors will apply, but the courts have typically tolerated a greater level of restriction. This is because, unlike agreements between an employee and employer, SPAs and shareholders’ agreements are typically bespoke and negotiated commercial agreements between parties of more equal bargaining power, and are just one part of a larger bargain for which the individual is being paid, compensated or offered a valuable opportunity (such as share ownership). As a result the scope and period of the covenants are often between six months and three years, however where this type of restriction starts from some undefined future date (i.e. the date on which an individual ceases to be a shareholder) they may still be considered to go beyond what is reasonably necessary to protect the Company’s legitimate business interests.
With special thanks to Sophie White, Partner at Abbiss Cadres LLP who provided expert employment law input for this article. Abbiss Cadres is a professional services firm providing employment, pensions, incentives and immigration law, tax advice, people consulting and communications services.
Is this brief too brief? Want to know more about restrictive covenants in employment agreements? (of course you do) Expert legal advice is on hand from MJ Hudson’s M&A team. Just contact any of the On Target team (details below) or your usual MJ Hudson M&A contact, and we’ll gladly help.
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MJ Hudson’s M&A and Private Equity transactions team acted as English legal counsel to Cognovia Capital on its disposal of Interlock Medizintechnik GmbH to Water Street Healthcare Partners. MJ Hudson previously advised Cognovia Capital on the acquisition of Clinipak Limited, the UK arm of Interlock.
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