Restraint of Trade clauses and Share Purchase Agreements
In a recent case the Court had to consider whether a restrictive covenant in a Share Purchase Agreement was void as being an unreasonable restraint of trade. The clause restricted the seller of the company, who was its original founder, from setting up in competition or soliciting business from the company’s clients.
On the face of it, the restraint was for a period of 2 years, but in practice it was scheduled to last for at least 81/2 years as the founder’s shareholding was sold and paid for by instalments.
Despite its length the Court upheld the validity of the clause. It was not an unreasonable restraint of trade because there was substantial goodwill in the business and the buyer had paid a very substantial price for it. The clause had been fully negotiated on a level playing field and it was clear that the seller would be a formidable competitor if he entered into competition. He was in fact retained as a non-executive director and chairman and the minimum period of 81/2 years was not unreasonable in the circumstances.
There were also clauses in the agreement which provided that, in the event of a breach of the restrictive covenant, the buyer would not be obliged to pay future instalments of the purchase price and would be entitled to exercise an option requiring the seller to sell the remainder of his shares at a consideration based on net asset value. The seller argued that this clause was void as a penalty, but this argument was rejected. The Court said there was commercial justification for the clause, namely, the adjustment of the purchase price based on substantial loss of goodwill, and again the clause had been negotiated on a level playing field. It was not an oppressive clause, but was primarily intended to deter the seller from breaching the restrictive covenant.
This decision shows that the courts will be prepared to uphold a lengthy non-compete covenant where it is intended to protect the buyer’s interests in the business that has been purchased and the parties have negotiated on an equal footing. It should be noted, however, that neither UK nor EU competition law applied on the facts of the case. Under the EC guidelines on ancillary restraints, which are also applied by the UK competition authorities, a 3 year non-compete period will generally be acceptable where both goodwill and know-how have been acquired and a 2 year period will be acceptable where only goodwill is involved. Longer clauses may still be justified in a limited range of circumstances.
Audit clauses in Supply Agreements
The High Court has upheld the terms of an audit clause in an agreement for the supply of services and ordered the supplier to provide the client with information and documents which it requested under the clause, including documents that were commercially sensitive and revealed the supplier’s underlying costs.
The request for information and documents was made after a dispute had arisen between the supplier and the client in relation to the supplier’s claim for increased costs. The client had entered into a contract with the supplier relating to a new tram operating system in Manchester. Subsequently, major differences arose between the parties about increased costs and the cause of those increases and delays in the project. The client requested the supplier to disclose a very broad range of information and documents and the Court ruled that the supplier was obliged to disclose them.
This case shows that great care should be taken in drafting and agreeing the wording of an audit clause, especially if one party wishes to avoid having to provide information relating to its costs or other commercially sensitive information.
Withholding consent under commercial agreements and the test of reasonableness
The High Court has ruled that an objective standard of reasonableness applies in deciding whether one of the parties to a financial transaction had withheld its consent in “a commercially reasonable manner” when the other party requested consent to the early termination of a finance agreement.
The finance agreement contained an early termination clause which required the party wanting to terminate the agreement to obtain the consent of the other party. The clause specified that the other party should act in “a commercially reasonable manner” in deciding whether to give consent.
When consent for early termination was requested, the other party refused to consent unless it was paid 5 years fees. The Court held that consent had been withheld in a commercially reasonable manner. It applied an objective standard of reasonableness under which the party withholding consent simply had to show that a reasonable commercial person in its position might have reached the same decision. However, it did not have to go on to show that its decision was justified. The party was entitled to take into account its own commercial interests in deciding what was commercially reasonable and did not have to carry out a balancing exercise between its own interests and those of the other party.
The comments in this note are of a general nature only. Full advice should be sought on any specific problems.