Shareholder Covenants for Senior Executives

Many senior executives will be subject to restrictive covenants as part of their employment contract or under a shareholders’ agreement. Such covenants are invalid if they constitute an unenforceable restraint of trade, which is determined by factors such as whether the covenant is no wider than what is reasonably necessary for the protection of a legitimate business interest.

Whether the covenant is part of an employment contract or a shareholders’ agreement is crucial in determining whether such clause is valid or an unenforceable restraint of trade.

Covenants in a shareholders’ agreement are subject to a lower level of scrutiny by the courts than with restrictive covenants in an employment contract. By way of example, in Ideal Standard International SA v Herbert [2019] IRLR 431, the High Court upheld the validity of a 18-month non-compete covenant in a shareholders’ agreement on the basis that “such clauses are negotiated in a commercial context and have the legitimate aim of preventing vendors from attacking the goodwill of the partnership or business from which they have just transferred. Towards the other end of the spectrum are ordinary employees who have a small shareholding in their employer-company as part of a share participation scheme”. The High Court took into account that the Defendant was a senior executive with a substantial shareholding interest worth approximately €1.2 million. The substantial shareholding interest was a key factor in concluding that the 18-month non-compete covenant was reasonable.

By contrast, in Law by Design Ltd v Ali [2022] IRLR 610, the Defendant was an employment law solicitor in a boutique law firm that entered into a shareholders’ agreement with the founder and the firm pursuant to which in return to a 3% shareholding, she entered into a 12-month non-compete covenant. The High Court held that the non-compete in the shareholders’ agreement was unenforceable, taking into account that the Defendant’s shareholding interest was minimal and a “very long way” from cases where a shareholders’ agreement was entered into as part of a commercial arrangement involving the sale of part of a business (such as in Herbert).

The reason why the courts adopt a lenient approach in shareholder agreement covenant cases (where the shareholding interest is substantial) is because the courts assume that the parties are experienced commercial parties with greater equality of bargaining power. By contrast, ordinary employees with a small shareholding in their employer-company have less bargaining power when agreeing to become subject to a restrictive covenant.

Farore Law is a leading boutique law firm that has a wealth of experience in advising the senior executives in restrictive covenants and executive remuneration. We are well placed to provide appropriate advice regarding the enforceability of contractual terms, seeking a settlement agreement and commencing or defending litigation in the High Court or the Employment Tribunal.

Please contact us if you require legal advice.