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Restrictive Covenants: Finding the right condition(er)...

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Restrictive Covenants: Finding the right condition(er)...

The High Court very recently handed down a judgment in the ongoing dispute between known hair salon chain ‘Rush Hair’ and Ms Gibson-Forbes (“GF”). Last year, GF negotiated with Rush to sell her shares in the franchise and set out to start her own salon. As part of the deal, restrictive covenants were put in place, in order to protect Rush’s access to clients in the area. A dispute subsequently came about and Rush sued GF for breaching those covenants. The focus of the case was on how to construe and interpret restrictive covenants; often considered to be a notoriously tricky and ‘grey’ area of law.

The Conditions

In this case, Rush imposed two covenants: an employee covenant and a non-compete covenant, both of which prohibited GF from engaging in certain activities for two years following the sale of shares.

The employee covenant prevented GF from enticing, soliciting or employing key employees from Rush at her new independent salon. GF was also prohibited from directly, or indirectly, engaging or being employed in any competing business within a certain area, as set out by the non-compete covenant.

Despite the terms of the covenants, GF set up shop a mere 300 metres from the Rush salon, prompting swift legal action from Rush. In Court, GF claimed that the covenants were so unreasonable that they amounted to a ‘restraint of trade’, yet Rush sought to demonstrate that it was entitled to enforce the covenants to protect its business. As such, the Court was provided with an opportunity to give some guidance as to how covenants should be interpreted and enforced.

Enforceability

Restrictive covenants can be a useful tool in protecting your business interests in different ways, though the key principle is that they must be reasonable in order to be enforceable. When assessing reasonableness, the Court will firstly consider what the covenant means. If there is any ambiguity surrounding a contractual provision, a ‘commercially sensible’ construction will be favoured.

They will then consider whether those benefiting from the covenant have demonstrated a legitimate business interest that requires protection and whether the covenant is no wider than reasonably necessary to achieve that protection. At this point the Court will assess reasonable necessity by looking at the agreement as a whole, from the perspective of a reasonable person in the position of the parties when the contract was made. Consequently, if you are proposing a restrictive covenant to your benefit, ensuring it is clearly defined and relevant to meet a legitimate business interest is vital to ensuring that the covenant is enforceable. This can often be a very difficult exercise.

Untangling the knots in this case

In this case, the first task for the Court was to consider whether or not the meaning behind the employee covenant prohibited GF from soliciting, enticing, canvassing or employing specific individuals (either on her own behalf, or as agent for another). The Court focused on the agreement as a whole, noting that only binding the individual and not the limited company (of which she was a director) would defeat the purpose of the clause. Consequently, not binding the limited company to the covenant would deprive it of commercial sensibility. The covenant therefore was enforceable against GF and her company.

In terms of the non-compete covenant, the Court was not persuaded by GF’s argument that the covenant should be narrowly construed to encompass simply the sale, promotion and use of Rush’s hair products. The Court again looked at the context when deciding that, despite the lack of definition in the agreement as to what ‘Rush business’ included, it was clear that this covenant referred to the hairdressing business of Rush.

Protection

With the Court ruling in their favour, Rush’s case demonstrates how restrictive covenants can be used to bolster the protection of your business. When hiring new employees from your business rivals, be wary of any restrictive covenants that may be lurking in their employment contracts. Similarly, when saying farewell to valuable employees, be sure to consider the protection that a restrictive covenant can offer. And finally, as demonstrated by Rush, be savvy in respect of the benefits of non-compete clauses, which can be immeasurably useful to restrict potential competitors (when property drafted!)

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By Louis Muncey

THE CONTENTS OF THIS ARTICLE ARE INTENDED SOLELY FOR INFORMATION PURPOSES ONLY AND SHOULD NOT BE CONSTRUED AS LEGAL ADVICE OR FINANCIAL ADVICE OR OPINION IN ANY SPECIFIC FACTS OR CIRCUMSTANCES.

© 2016 HYBRID LEGAL LIMITED.