How far can you go to protect what you paid for in a business purchase?

richard-buonoh&sWhen negotiating the purchase of a business, it is usual for provisions dealing with post-completion restrictions on the seller to be limited to 2-4 years from the completion date.  These restrictions cover matters such as the non-solicitation of customers, suppliers and staff, and competition with the buyer.  It is commonly held that a period of 2-4 years is reasonable and is not in “restraint of trade” .

However, in the recent case of Cavendish Square Holdings BV and another v El Makdessi [2012] the High Court decided that a restriction which, in the absence of breach, would last for a minimum of eight and a half years, was not in restraint of trade.  The court held that this period was not unreasonable in the circumstances as it was tied to a relevant interest of the buyer.  The High Court supported its decision with the following key factors:

  • The restrictive covenant clause had been fully negotiated by the buyer and seller who were on an equal footing;
  • There was significant goodwill in the business, for which the buyer had paid a very substantial amount of money; and
  • It was determined that the seller would be a formidable competitor to the business in the event of breach of the restrictions and, as the seller was continuing as a non-executive director and minority shareholder of the business, any such breach would be significant.

Further, in Cavendish there were additional clauses in the share purchase agreement which provided that: 1) the buyer would not have to pay any future instalments of the purchase monies due and 2) would be entitled to exercise an option requiring the seller to sell the remainder of his shares in the business to the buyer for an amount based on net asset value.

The court held that these additional clauses were not “penalty clauses”  for the following reasons:

  • The inclusion of the clauses was commercially justified (the adjustment of the purchase price based on significant loss of goodwill);
  • The clauses were not extravagant or oppressive;
  • The main purpose of the clauses had not been to deter breach of the contract; and
  • The share purchase agreement had been negotiated by the parties on an equal footing.

For more information on post-completion restrictions, or if you are thinking of buying or selling a business, please contact the Company & Commercial Department.

Richard Buono
Associate
Company & Commercial Department 
RBuono@LawBlacks.com

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