Construing restrictive covenants in a Shareholders’ Agreement: the Court of Appeal’s decision in Guest Services Worldwide Limited v Shelmerdine

Facts

The Appellant company (“Guest Services”) makes maps for distribution to the guests of luxury hotels. The Respondent, Mr  Shelmerdine, was the founder of the business. It was sold to another company, which was subsequently placed in administration, whereupon it was purchased by Guest Services.

Guest Services initially retained Mr Shelmerdine as an employee. In July 2015, the parties entered into a consultancy agreement (the “Consultancy Agreement”). Thereafter, in June 2016, Mr Shelmerdine became a shareholder in Guest Services, pursuant to a shareholders’ agreement (the “Shareholders’ Agreement”). The terms of each agreement included various post-termination restrictions, each of which was 12-months' long.

The fixed term of the Consultancy Agreement expired and the ad-hoc consultancy arrangements between the parties were thereafter terminated on 9-months’ notice. Upon termination, it was alleged that Mr Shelmerdine used a map created for Guest Services in an attempt to solicit an existing client of the company, and, to the same end, that he had made contact with various branches of the Ritz. Guest Services brought proceedings, seeking injunctive relief in support of the restraints in the Shareholders’ Agreement.

First instance decision

His Honour Judge Halliwell, sitting in the Manchester Business and Property Courts, held that the restrictive covenants in the Shareholders’ Agreement did not apply to Mr Shelmerdine. Construed properly, the Judge held that the restrictions – which applied to ‘Employee Shareholders’, as a distinct class of shareholders in the company – did not apply to a shareholder who has ceased to be an employee, director and/or agent of the business.

The Judge held that, were he wrong about that construction, each of the covenants went further than was reasonably necessary for the protection of the legitimate interests of the company. That was because, on the Judge’s alternative construction, the restraints would apply to a shareholder, notwithstanding the fact that he or she had ceased to be an employee, director or agent of the business – and could therefore apply indefinitely to any existing shareholder. Since ordinary shareholders (cf. ‘Employee Shareholders') would not have access to confidential information, including the company’s client contacts, the Judge was of the view that the restraints were unenforceable. 

Decision of the Court of Appeal

The decision was overturned on appeal. Lady Justice Asplin, giving the decision for the Court, held that the Judge had misconstrued the relevant provisions of the Shareholders’ Agreement and that the 12-month duration of each of the restraints was reasonable.

The Court of Appeal found that the Judge was wrong to conclude that the restraints would no longer apply to a shareholder when he or she ceased to be an employee, director or agent of the company. Those provisions had to be viewed in light of the company’s Articles of Association, which required Guest Services to purchase an employee’s shareholding in such an event. Any alternative construction would deprive the restraints of their commercial sense. Properly construed, the restraints applied until a shareholder ceased to be a shareholder (ordinarily, on the compulsory purchase of his or her shares). 

The Court of Appeal also unanimously held that each of the post-termination restraints was enforceable. The 12-month duration of those restraints had to be assessed in light of the status of the agreement – as a Shareholders’ Agreement – and therefore one which did not fall neatly into the traditional ‘vendor-purchaser’ / ‘employer-employee’ categories. On the facts, the Court concluded that the clause appeared “in a shareholders’ agreement made between experienced commercial parties” [43]. 

Conclusion

The Court of Appeal was correct to overturn the Judge’s decision on the construction issue. The Judge placed considerable weight on the fact that ‘Employee Shareholder’ was defined by reference to ‘employees, agents and directors’ in the present tense. With respect, however, the Judge’s construction of the restraints is incompatible with their commercial purpose (indeed, their very nature as post-termination restraints). 

Perhaps of more long-term significance is the Court’s decision on the enforceability of restrictive covenants in a shareholders’ agreement. The Court recognised that agreements of that type are not readily comparable to ‘vendor-purchaser’ agreement or an ordinary contract of employment. But the very status of the agreement - as one between a business and its shareholders – appears to have been all but determinative of the Court’s assessment of the reasonableness of the restraints. Notably, the Court’s decision gives little (or no) consideration to each of the specific restraints, its purpose or the reasonableness of its duration when viewed in light of that purpose. Query if such an approach is appropriate, indeed permissible, where the very cases cited by the Court of Appeal caution against rigid categorisation of that sort.

The full judgment can be read here.