Restrictive Covenants in Shareholder Agreements

When shareholders stop working for a company, I am often asked about provisions that have been included in a shareholders agreement or in the articles that say they are forced to offer their shares for sale to the remaining shareholders or the company.

Generally, most of these discussions revolve around the process and what value will be attached to the shares. But an interesting recent court case looked at the provisions of a shareholders agreement that limited the right of the shareholders to set up, or to work in any competing business. 

In Guest Services Worldwide Ltd –v- Shelmerdine a consultant was also a shareholder. When the consultancy came to an end, the consultant retained his shares in the company (they were not purchased by any of the other shareholders). However, a shareholders agreement included restrictions on the former-consultant’s ability to set up or work in any competing business for as long as he remained a shareholder, even though his consultancy had ended. In fact, those restrictions applied for 12 months after he disposed of his shareholding (assuming he could do so).

The former consultant claimed these restrictions were unreasonable and unenforceable. The Court of Appeal disagreed with him and upheld the restrictions. The court said that shareholder agreements were not readily comparable to an ordinary contract of employment. The very status of the agreement - as one between a business and its shareholders – was key to the Court’s decision to uphold the restrictions.

It was notable that the court declined to give detailed consideration to each of the specific restraints, its purpose or the reasonableness of its duration. That approach may be questionable but for now at least, this remains good law and a powerful authority to support restrictions in shareholders agreements.

For more information on the topic please contact Paul Lunt directly.