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Breach Of Non-Compete Clauses – What Can You Do?

Napthens - December 11th 2013

A recent case considered whether a buyer’s obligation to pay deferred consideration was lost in the event of a seller breaching the restrictive covenants in a share purchase agreement.

Background - El Makdessi v Cavendish Square Holdings BV & another (2013)

M (the seller) sold his shareholding in a company to Cavendish (the buyer) pursuant to a share purchase agreement.

It was agreed that some of the share price would be paid on completion, with the remainder paid in subsequent instalments. It was also agreed that the seller would enter into a restrictive covenant prohibiting him from being involved in a competing business for a certain period of time.

If the seller breached a restrictive covenant, the agreement stated that the buyer:

  • Did not have to make any deferred payments to the seller and
  • Could force the seller to sell the remainder of his shares to the buyer at substantially lower price than if there had not been a breach

It was subsequently discovered that the seller had breached his restrictive covenants and as a result the buyer sought to rely on the above clauses.

Were the clauses enforceable?

The court held that the clauses were unenforceable, for the following reasons:

  • The clauses were extravagant and had the main purpose of acting as a deterrent rather than as a true reflection of loss suffered by the buyer. The range of losses resulting from the breach was wide and a small, short-lived breach would have the same effect as a serious breach of the covenant
  • The clause was not a genuine pre-estimate of the buyer’s loss as it was difficult/impossible to predict the losses flowing as a result of illegitimate competitive acts
  • There was no commercial justification for the inclusion of the clauses

What does it mean for you?

The message from the court is clear: an extreme provision of this type contained in a share purchase agreement is likely to be held unenforceable, unless there is sufficient commercial justification for such a provision.When deciding whether to include such provisions in a share purchase agreement, it is important to consider the wider commercial aspects of the deal and the likely consequences of any breach of the agreement.

The court confirmed that it is possible to avoid the issue of penalty clauses by stating that compliance with any restrictive covenants is a condition of any subsequent payments. This will achieve the desired result of avoiding subsequent payments in the event of a seller’s breach of covenant.