Restraint clauses in Shareholders Agreements
A shareholders agreement may include restraint clauses which seek to prevent a shareholder from competing with the company, disclosing confidential information and/or soliciting the company’s clients or employees. While these clauses are put in place to apply for the duration of a person’s shareholding, importantly these clauses are used to govern shareholders after the termination of their relationship with the company. They do this by preventing a former shareholder from engaging in activities which might harm the company. In this respect, they ensure that a shareholder does not use the knowledge and expertise gained during their association with the company to the disadvantage of the company.
Enforceability of restraint clauses
There is a common law presumption that a restraint clause will be void and unenforceable in circumstances where its sole purpose is to protect against competition. This is because competition is generally encouraged at common law. As such, courts will not impose undue restrictions on the ability of a shareholder to carry out their trade or business. However, courts have recognised that there may also be circumstances in which it is reasonable for a company to seek to protect its legitimate interest through the use of restraint clauses.
A restraint clause will generally be considered enforceable when:
there is a legitimate interest;
the restraint is necessary to protect that legitimate interest; and
the restraint is reasonable in both scope and duration.
Cascading restraint clauses
Courts have the power to sever a restraint clause in circumstances where it is unreasonable in light of the legitimate interests being protected. Generally a restraint clause is unreasonable and unnecessary when the areas and timeframes are unreasonably excessive. In circumstances where a court has For this reason, many restraint clauses will include a cascading subset of clauses which provide different levels of restraint. Each variable is treated as a different clause, which means that where one level of restraint is deemed too harsh, a lower level of restraint can be enforced without the entire clause being invalidated.
For example, a restraint clause in a shareholders agreement might be drafted to operate for the duration of:
12 months, and if that is unenforceable;
6 months, and if that is unenforceable;
3 months.
How can we help you?
If drafted carefully and tailored to the specific circumstances of the company, restraint clauses can be a useful way for companies to protect their confidential information, proprietary rights and interests more generally.
Merton Lawyers are experts in corporate governance and preparing bespoke shareholders agreements. To discuss how we can assist you, please contact our corporate team to arrange for an initial consultation.
