The recent High Court decision in Law By Design Ltd v. Ali provides a helpful reminder of some of the factors to consider when addressing the complex question of enforceability of post-termination non-compete restrictions, as well as the interplay between restrictions entered into in the capacity of shareholder and those entered into by an employee in a service agreement.
The facts
In 2013, Ms Ali began her employment as an associate director with Law By Design Ltd (LBD), a Manchester-based boutique employment law firm which works mainly for NHS clients. In 2016, Ms Ali entered into a shareholders agreement that included a restrictive covenant which provided that she could not “be engaged, concerned or interested in, or assist, a business which competes, directly or indirectly, with a business of the Company” in an area in which LBD had operated in the previous 12 months.
In 2018, Ms Ali was promoted to the role of director, equivalent to a salaried partner. In 2021, Ms Ali entered into a service agreement and received a substantial pay rise, in an attempt to secure her continued employment with LBD following a proposed team move. The service agreement contained a 12-month non-compete clause which prohibited her from being involved in a Restricted Business, defined as any business that was in competition with LBD and specifically the areas of LBD in which she had been involved to a material extent in the 12 months prior to the termination of her contract. It was, therefore, narrower than the shareholders agreement restriction identified above.
A few months later, Ms Ali resigned to join another national law firm which also provided services to NHS clients in the North West of England. After protracted correspondence, Ms Ali eventually gave interim undertakings pending the substantive hearing at which LBD sought final injunctive relief.
The decision
The High Court (the Court) concluded that LBD had a legitimate business interest to protect. It granted an injunction to enforce the non-compete in the service agreement, but decided that the restriction in the shareholders agreement was too widely drafted to be enforceable.
The legitimate business interest that the Court decided LBD was entitled to protect was “the customer connections built up by LBD employees providing legal services to NHS clients”. “The principal part of LBD’s business is “the provision of employment law services to NHS bodies” in the North West of England and to a single NHS body in Hertfordshire. These were the services to be provided by Ms Ali for her new employer.
However, crucial to the Court’s decision, in relation to the service agreement, was the definition of Restricted Business, as above, because it limited the restriction to the parts of LBD’s business with which Ms Ali had been involved to a material extent and “proximately” before her departure. The Court said that it was an “uncomplicated conclusion” to reach that the restrictive covenant was drafted in a way that was not wider than was reasonably necessary to protect LBD and was therefore enforceable.
Conversely, the Court concluded that the non-compete clause in the shareholders agreement was unenforceable, on the basis that it was too wide to be reasonably necessary to protect LBD’s legitimate business interests. The clause would prevent shareholder involvement in any other business in England and Wales that directly or indirectly competed with any part of LBD’s business as operated in the 12 months before the shareholder ceased to be a shareholder. This meant that the clause would operate to restrict a shareholder, irrespective of whether or not they had had any role in the conduct of that part of the business.
Ordinarily, non-compete clauses in shareholders agreements are more likely to be considered reasonable and enforceable given the relative equality in bargaining power (as compared with the employer/employee relationship), the fact that any restrictive covenants are negotiated in a commercial context and, where imposed in the context of the acquisition of a business, the clear legitimate aim of preventing vendors from attacking the goodwill of the partnership or business which they have just transferred.
However, the Court referred to a number of previous cases and noted that it is not simply a matter of categorisation: non-compete clauses in employment agreements on the one hand, non-compete clauses in shareholders agreements on the other. There is a spectrum: at one end are non-compete clauses for the vendor of shares (in a partnership or company) which are generally enforceable, and towards the other end of such spectrum are “ordinary employees”, who have a small shareholding in their employer as part of a share participation scheme. In those circumstances, the distinction between restrictive covenants in service agreements as opposed to shareholders agreements becomes less clear. In this case, the restriction in the service agreement was more narrowly drawn and, ultimately, more enforceable.
Takeaways
While it is relatively rare for a 12-month non-compete restriction to be upheld, we do not believe this case will mark a sea change in terms of the enforceability of non-compete restrictions, which are notoriously more difficult to enforce than the less restrictive provisions, such as those which restrict dealing with customers or soliciting employees. In this case, the Court was influenced by the context and timing of when Ms Ali agreed to the non-compete restriction. It also placed weight on a business plan which Ms Ali had provided to her new employer, referring to “transitioning” clients to the value of more than a third of LBD’s turnover. The Court said that it was clear that her plan was, unless her restrictions were enforced, to move clients from LBD to her new firm. It took the view that enforcing the non-compete clause was a “necessary and practicable” solution to the difficulty of policing some of the other restrictions (confidential information and non-solicitation).
The case is also a useful reminder that, even if an employer can establish a legitimate business interest, it is important that any non-compete clause is drafted so that it is no wider than is necessary to protect that interest. If the shareholders agreement restriction had been in the service agreement, the injunction would not have been granted.
Possible changes in the law
A government consultation on the use of non-compete clauses closed last year, but the outcome has not yet materialised. Two possible measures were envisaged:
- Making non-compete clauses in contracts of employment enforceable only where the employer provides compensation for the period that the clause prohibits the individual from working for a competitor or starting their own business. Such a step could be accompanied by the following complementary measures:
- An obligation for employers to disclose the exact terms of a non-compete clause in writing prior to the start of the employment relationship.
- A statutory limit on the duration of a non-compete clause.
- Banning non-compete clauses altogether.
On 2 March 2022, Paul Scully MP confirmed that the government’s response to the consultation will be published “in due course”.
