Enforceability of Restrictive Covenants

The High Court upheld restrictive covenants of a two-year duration, demonstrating the approach of the courts in cases involving vendor-purchaser agreements. The decision also provides clarification of the limits of the ‘corporate veil’ doctrine.

Rush Hair Limited (“Rush Hair”), a hair and beauty business, sought an interim injunction to enforce restrictive covenants in a share purchase agreement with the first defendant (“D1”). The High Court held that the two-year covenants were enforceable.

Facts 

D1 was a hairdresser and director of a number of hairdressing businesses, including the second defendant (“D2”). In 2015, she sold the shares in two salons to Rush Hair under an agreement which contained the following post-termination restrictions: 

• a two-year non-compete clause, which prevented her from working in any business that was similar to, or otherwise competed with Rush Hair; and
• a prohibition of the same length which prevented D1 employing certain employees from her former salon.

Rush Hair argued that, in breach of these clauses, D1 had opened a new salon and employed former employees from her previous salon. D1 argued that the employment contracts were made with D2, and contested the validity of the restrictive covenants. D2’s position was that it was not bound by the restrictive covenants, since the share purchase agreement was between the Rush Hair and D1.

The judgment of Deputy Judge Mr Martin Chamberlain QC

The Deputy Judge applied TFS Derivatives Ltd v Morgan [2004] EWHC 3181 (QB); [2005] IRLR 246 to assess the reasonableness of the covenants. Under that case: (a) the court must determine the proper construction of the covenants; (b) the party seeking to enforce them must show it has a legitimate business interest in doing so; and (c) the restrictions must be no wider than is reasonably necessary to protect that interest.

The Court considered whether the non-employment covenant extended to employment by D2, a company in which D1 was a director and shareholder, or was limited to direct employment by D1. The Court approved the wider construction. While it would not pierce the corporate veil (as there was no evidence that D2 had been established to conceal D1’s identity as employer or to evade liability: Petrodel Resources Ltd v Prest [2013] UKSC 34; [2013] 2 AC 415), the restrictive covenant should be given a commercially sensible interpretation as it was ambiguous (Prophet plc v Huggett [2014] EWCA Civ 1013; [2014] IRLR 797). Rush Hair was aware that, before D2 was incorporated, D1 operated through other limited companies in the past. Any restriction would be ‘toothless’ if it did not bind her as an agent.

The Deputy Judge also held that both restrictive covenants were enforceable. Emphasising that this case involved a vendor-purchaser agreement, he held that:

• The non-employment clause protected part of the goodwill of the company being sold, namely the connection between particular stylists and their clients;
• The geographical limit of the non-compete clause, which prevented D1 working where she lives, was reasonable. She had previously worked further afield; and
• The two-year duration of the covenants was reasonable.

Comment

This decision provides further evidence of the diverging approach of the courts in vendorpurchaser disputes, as opposed to those between employers and employees. In contrast to previous employment disputes (see Duarte v The Black and Decker Corp [2007] EWHC 2720 (QB); [2008] 1 All ER (Comm) 401), the Deputy Judge was willing to uphold lengthy restrictions on the basis that ‘there is no vendor-purchaser case in which an otherwise reasonable covenant has been held unreasonable on grounds of duration’.

The judgment also shows that, in light of Petrodel, the courts will only pierce the corporate veil to enforce a covenant personally where: (a) the company is being used to conceal the identity of a party, ‘as a cloak or a sham’; or (b) the company has been interposed to defeat an existing legal right. The intentions of the party relying on the incorporation of the company, as inferred from past practice, appear to be important. 

Finally, the judgment also demonstrates the potential flexibility of the doctrine in Prophet plc v Huggett. In Prophet, the Court of Appeal held there was no ambiguity in the covenant and interpreted it narrowly. However, relying on the ambiguity in the non-employment clause, the Deputy Judge here held that, since Rush Hair knew that D1 had previously operated through limited companies, a commercially sensible interpretation would bind her when acting as a company agent. It is arguable, however, that if parties know something of importance for which they do not explicitly contract, a commercially sensible interpretation may suggest this was their intention.

The full judgment can be read here.