A recent finding by the Court of Appeal draws attention to the importance of careful drafting when combining shareholder restrictive covenants and compulsory transfer provisions in a shareholders' agreement.
It is of course a common practice to include non-compete restrictions in a shareholders' agreement. It is also common for small private limited companies to incorporate compulsory transfer provisions, requiring employee or director shareholders to offer their shares up for sale if and when they leave the company. However, the case of Guest Services Worldwide Limited v David Shelmerdine shone a light on the potential consequences if these clauses, and the way they interact, are not drafted with great care.
Mr Shelmerdine was an employee shareholder of Guest Services Worldwide Limited (GSW), and when he left the business he became subject to the compulsory transfer provisions in the shareholders' agreement. However, despite a transfer notice being deemed served at the time he left, Mr Shelmerdine ended up keeping his shares. Meanwhile, the restrictive covenants in the agreement operated to restrain shareholders from engaging in any competing business activity for as long as they remained a shareholder, and for 12 months thereafter.
As Mr Shelmerdine, apparently by incomplete operation of the compulsory transfer provisions, remained a shareholder after he left the business, it followed that he could remain bound by these restrictions indefinitely. Mr Shelmerdine argued before the High Court that the restriction was unreasonable, and HHJ Halliwell ruled in his favour. However, the Court of Appeal reversed this decision.
The Court of Appeal found that, because it was 'very unlikely' that a shareholder would find themselves in this position (despite the fact that Mr Shelmerdine had in fact done so), the clause was not unreasonable and did not go beyond what was necessary to protect GSW’s legitimate interest, and was therefore enforceable. The court's ruling was therefore that Mr Shelmerdine remained bound by the restrictive covenants for as long as he held the shares, and for 12 months afterwards.
Although these are undoubtedly narrow facts, the case serves as a warning – both to companies, to ensure that compulsory transfer provisions in shareholders agreements are water-tight, and to individual employee shareholders, to be wary of the risk of restrictive covenants that apply in the context of their shareholding continuing to apply after their employment has ended in circumstances where they may continue to hold shares.
I do not consider that the clause should be declared to be unreasonable on the basis of the relatively unlikely possibility that there may be considerable delay or the extreme and very unlikely possibility that a Shareholder may be locked in indefinitely.