What should the scope and duration of restrictive covenants be?
Clients often ask what the scope and duration of restrictive covenants should be in investment agreements (and similarly, in sale and purchase agreements). For good reasons, lawyers avoid giving a general answer to these questions and you will not find them either in legal articles and commentary.
The established law is that the scope of restrictive covenants must be no greater than reasonably necessary to protect the legitimate business interests of the party for whose benefit they are being given. By definition, this means that there are no generally applicable rules which can be applied to all circumstances. The general view however is that the courts will take a less restrictive approach where covenants are given in the situation of the sale of a business.
The temptation can sometimes be to include overly-broad covenants in agreements. The thinking is that these will act as a practical deterrent to the covenantor, who will not want to risk breaching them and incurring legal fees in defending enforcement action.
A recent case[1] acts as a warning to parties that courts will not uphold covenants which are unreasonable in terms of scope and duration. This serves as a valuable reminder to carefully draft covenants to ensure they align with legitimate business needs.
The case of Literacy Capital plc v Vanessa Webb
This case related to restrictive covenants given by an individual in an investment agreement, entered into following a sale of shares by the individual. The covenants:
- sought to prevent the individual from being involved in a business which competed with any group company in the group which included the individual’s employer company
- applied to the whole of the UK
- could potentially last for up to 10 years
The claimant made an application for an interim injunction to restrain the individual from trading in competition with the claimant’s group. The court determined that the covenants were void and unenforceable and that the claimant had no arguable case that they were reasonable in scope and duration.
The outcome emphasises the importance of proportionality in restrictive covenants, particularly regarding their geographic scope and duration.
Court rationale
In particular:
- the court found that the extension of the covenants to any group company was far beyond any legitimate protectable interest of the claimant
- the duration of the covenants was far past the duration of covenants allowed in sale of business cases
- the geographical scope of the covenants (the entire UK) was not justified -the claimant had not shown any evidence of the relevant geographical scope of business beyond two counties in the England
What lessons can be learned?
Key takeaways from this case include:
- specify the legitimate interest for which protection is being sought. This could be, for example, the goodwill and confidential information relating to a particular business and the customers and trading relationships which the individual will have knowledge of as a result of the individual’s employment
- make sure that the covenants do not exceed what is reasonably necessary to protect this legitimate interest
- for the scope of the covenants, do not attempt to protect businesses in which the individual will not be involved or have any knowledge
- for the duration of the covenants, consider the rationale for the length of the restrictions in light of the interest being protected
- for the restricted territory, limit this to the area in which the protected business will be conducted
This case highlights the importance of drafting restrictive covenants in investment and sale agreements with care. Terms must be reasonable and appropriate in scope, duration, and geographic reach to protect legitimate business interests. Drafting restrictive covenants with precision not only enhances their enforceability but also ensures fairness and clarity for all parties involved.
[1] Literacy Capital plc v Vanessa Webb [2024] EWHC 2026
