In Rush Hair Limited v Hayley Gibson-Forbes and S.J. Forbes Limited [2016], the High Court considered the interpretation and enforceability of restrictive covenants in a share purchase agreement, including the circumstances in which the court will pierce the corporate veil where alleged breaches are carried out by a company controlled by the seller.
Background
The claimant, Rush Hair Limited (Rush), a hair and beauty business, ran and franchised salons. The franchised salons were licensed to use the Rush brand and trade marks. Hayley Gibson-Forbes (GF) was a successful hairdresser and businesswoman and S. J. Forbes Limited (SJF) was a company incorporated by GF and her husband in May 2016.
In 2008, Rush entered into a franchise agreement with Hair (Windsor) Ltd, a company then owned by GF, to operate a Rush hairdressing salon in Windsor. The franchise agreement contained restrictive covenants given by GF. The franchise arrangement operated successfully and GF built a successful business in locations which, through Hair (Maidenhead) Ltd, also included Maidenhead and also Egham.
In September 2014 GF and her husband incorporated another company, Cre8heir Ltd, and in July 2016 the issued share capital of SJF was transferred to it.
Facts
On 9 March 2015, GF and Rush entered into a share purchase agreement (SPA) under which Rush agreed to buy the entire issued share capital of Hair (Windsor) Ltd and Hair (Maidenhead) Ltd for a total consideration of £40,000.
£15,000 of the consideration was payable six months after Completion provided that GF had not breached any clauses in the SPA. If GF were to breach any clauses in the SPA in that period the deferred consideration would not be paid.
Clause 7 of the SPA contained two restrictive covenants:
- 7.1.2 the Seller [being GF] shall not at any time during the period of two years from Completion, canvass, solicit, entice or employ JT, LH and CH [three named individuals]
- 7.1.3 the Seller shall not within the Territory…..for a period of two years from Completion directly or indirectly be engaged, concerned, employed or interested in any capacity whatsoever in a business which carries on a business similar to or which competes with the Rush business.
‘Rush business’ was not defined, although it was defined in the franchise agreement as Rush’s hairdressing business, including the operation and management of salons under the Rush brand.
‘The Territory’ was defined as ‘an area within a two mile radius around the address where the [two] Companies currently trade.’….[The two addresses were in Windsor and Maidenhead].
At Completion, GF received the initial purchase price of £35,000 under the SPA. GF did not subsequently receive the deferred consideration in October 2015 as Rush believed that LH and CH were already employed by GF and that by employing LH and CH, GF had breached clause 7.1.2 of the SPA. Rush did not therefore pay the balance of £15,000. GF accepted that if LH and CH were employed in breach of clause 7.1.2, Rush was entitled to withhold the deferred consideration. However, it was argued on behalf of GF, that it was not her but her company which was the employer.
Subsequently, in July 2016, GF opened a new salon in Windsor through SJF and engaged the third named individual, JT, as a consultant. The consultancy agreement was signed by GF for and on behalf of SJF.
Rush alleged in its Particulars of Claim that GF had breached both clauses 7.1.2 and 7.1.3, in that GF had set up a competing hair and beauty salon and had not only ‘employed’ JT but had also canvassed or solicited her to work as salon manager at S J Forbes Windsor.
GF contested the validity of the restrictive covenants.
Arguments
In relation to the non-solicitation covenant in clause 7.1.2, the key issue was the effect of the interposition of a company as the employer rather than GF directly. The wording of the clause did not cater for this. GF and SJF argued that the parties could have included a prohibition on employment by a company of which GF was a director and shareholder, but did not. Therefore, the clause should be construed as containing no such prohibition. Rush relied on Gilford Motor Co v Horne [1935] which held that a court will not allow a corporate vehicle to be used as a device to get around a valid restrictive covenant.
In relation to LH and CH, there was no dispute that they were employed in the salon in Egham by (probably) Cre8heir Ltd, although GF argued that they approached her for employment.
The other arguments put forward by GF and SJF included that the two year duration was too long (being twice the equivalent obligation in the franchise agreement) and the lack of geographical restriction.
In relation to the non-compete covenant in clause 7.1.3, GF and SJF argued that as the ‘Rush business’ was not defined, the clause was void for uncertainty, it extended geographically too far because it excluded GF from operating in Windsor where she lived (and where there were twenty eight other salons) and the two year period was too long, again being twice the period in the franchise agreement.
High Court analysis
Interpreting the SPA
Interpreting a document involves the ascertainment of the meaning which the document would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties in the situation in which they were at the time of the contract (Investors Compensation Scheme Ltd. v West Bromwich Building Society [1998]).
Where a contractual provision is ambiguous
It was permissible in a case where a contractual provision was ambiguous to choose a ‘commercially sensible’ meaning over one that leads to apparent absurdity, where the language of the provision was ‘truly ambiguous’ (Prophet Plc v Huggett [2014]).
Assessing the reasonableness of restrictive covenants
The Deputy Judge said that the proper approach to assessing the reasonableness of a restrictive covenant was explained by Cox J in TFS Derivatives Ltd v Morgan [2005] who said:
“First, the court must decide what the covenant means when properly construed. Secondly, the court will consider whether the former employers have shown on the evidence that they have legitimate business interests requiring protection in relation to the employee’s employment…Thirdly, once the existence of legitimate protectable interests has been established, the covenant must be shown to be no wider than is reasonably necessary for the protection of those interests. Reasonable necessity is to be assessed from the perspective of reasonable persons in the positon of the parties as at the date of the contract, having regard to the contractual provisions as a whole and to the factual matrix to which the contract would then realistically have been expected to apply.”
Although in that case the covenants were given by an employee, the Deputy Judge said that the basic three-part structure is equally applicable to covenants given by the seller of a business.
Interposing a company
The court considered the circumstances in which a person who covenants not to do something will breach the covenant if the prohibited act is done not by him but by a company with which he is concerned. Rush relied on the Court of Appeal decision in the Gilford Motor case (above) which was one of those considered recently by the Supreme Court in Prest v Petrodel Resources Ltd [2013]. In the Gilford Motor case the court concluded that a company had been created so that Mr Horne could avoid breaching restrictive covenants by carrying on his business through the company. The company in that case had been formed as a device, ‘merely as a cloak or sham’, to enable Mr Horne to carry on his business and avoid liability for beaching the covenants.
Lord Sumption in Petrodel (with whom the other members of the Supreme Court broadly agreed) noted that two separate legal principles underlay the cases in which the phrase “cloak or sham” had been used: first, the ‘concealment principle’ (“that the interposition of a company or perhaps several companies so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming that their identity is legally relevant”) and the ‘evasion principle’ (“that the court may disregard the corporate veil if there is a legal right against the person in control of it which exists independently of the company’s involvement and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement”). Lord Sumption regarded the Gilford Motor case as an example of the concealment principle.
Lord Sumption summarised his analysis of the case law in the following way:
“These considerations reflect the broader principle that the corporate veil may be pierced only to prevent the abuse of corporate legal personality. It may be an abuse of the separate legal personality of a company to use it to evade the law or to frustrate its enforcement. It is not an abuse to cause a legal liability to be incurred by the company in the first place. It is not an abuse to rely on the fact (if it is a fact) that a liability is not the controller’s because it is the company’s. On the contrary, that is what incorporation is all about.”
The Deputy Judge developed five propositions from the relevant case law, which are:
“First, a person who has entered into a covenant not to “employ” another must not employ that other either himself or through an agent. That is because the agent’s acts are, in law, those of his principal, the covenantor. This explains why, when a court enjoins someone from doing some act, the standard wording forbids the doing of the act “directly or indirectly”.
Secondly, when a company acts through its director, the director is normally the agent of the company, not the other way round. A covenant not to do a particular act can be framed so as to prohibit the doing of that act as agent for another. The covenant in the Gilford Motor case is an example. Whether any particular covenant prohibits acts done as agent for another is a matter of construction.
Thirdly, where a person who controls a company uses that company “as a cloak or sham”, i.e. “so as to conceal the identity of the real actors”, the application of the “concealment principle” enables the court to conclude that the acts apparently done by the company are, in fact, acts of the person controlling it (on Lord Neuberger’s analysis [in Petrodel] of Gilford Motor Co v Horne, because the use of the company as a “cloak” makes the company the agent of the controller).
Fourthly, where a controller interposes a company so that the separate legal personality of the company will defeat a legal right or frustrate its enforcement, the “evasion principle” enables the court to pierce the corporate veil, i.e. to treat the company’s acts as, in law, those of the controller.
Fifthly, where an act has in fact been done by a company and not by its controller (and where neither the concealment principle nor the evasion principle applies), it is not an abuse to rely on that fact.”
Covenants in business sale agreements
The court also considered the distinction between covenants in employment contracts and covenants in business sale agreements. The relevant principles were summarised in Cavendish Square Holdings BV v El Makdessi [2012]:
- The law distinguishes between covenants in employment contracts and covenants in business sale agreements. There is more freedom of contract between buyer and seller because it is in the public interest that the seller should be able to achieve a high price for what he has to sell. Goodwill would be well-nigh unsaleable if it was unlawful for the vendor to enter into an adequate covenant against competition.
- However, even in the business context, if a covenant goes further than is reasonably necessary to protect a legitimate business interest, it is void and will not be enforced.
- The court should be slow to strike down clauses freely negotiated between parties of equal bargaining power.
- The onus is on the claimant to establish the reasonableness of the restraints, but in a vendor-purchaser covenant, the onus was ‘not a heavy one’.
Rush argued that if it had not been possible to protect the goodwill of the business it was acquiring under the SPA by appropriate covenants, Rush would not have been willing to pay anything for the shares.
The Deputy Judge said that the purchaser was entitled to protect the goodwill of the business and if that was not possible (by appropriate covenants) the business would be worthless. An important part of the goodwill of the businesses, which Rush was entitled to protect, was the value of the personal connection between the individual stylists and the regular customers of those stylists. A customer would be less likely to return to Hair Windsor or Hair Maidenhead (and more likely to go somewhere else) if the regular stylist was no longer working there. It followed that Rush had a legitimate interest in ensuring, to the extent possible, that the employees of Hair Windsor and Hair Maidenhead remained. GF could not, of course, guarantee that the employees would remain but she could, and did, agree not to do certain things likely to cause them to leave.
High Court decision
Non-solicitation Covenant (Clause 7.1.2)
The principle in the Gilford Motor case did not assist Rush because there was no attempt to conceal GF’s role in the new Windsor salon. Neither the ‘concealment principle’ nor the ‘evasion principle’ applied. There was nothing to indicate that SJF was incorporated with the intention of concealing GF’s role in the business or to evade liability under the covenants. In fact GF’s involvement was prominently advertised on the SJF website. The consultancy agreement was entered into by GF as agent for SJF.
How, therefore, should clause 7.1.2 of the SPA be objectively construed? Did the clause prohibit only the activities of GF on her own behalf or did it extend also to activities as agent for another? The commonly used wording (‘either solely or jointly with or as agent for any other person, firm or company’) was absent. Ultimately, the proper construction of clause 7.1.2 must be ascertained from the language used in the context of the SPA as a whole and the factual matrix known to the parties.
The Deputy Judge concluded that the clause, on its natural meaning, was ambiguous. It could be read as precluding acts on GF’s own behalf or as agent for another. It was therefore permissible and appropriate to give the clause a commercially sensible meaning and that involved (as mentioned above) ascertaining the meaning which the clause would convey to a reasonable person having all the background knowledge which would reasonably have been available to the parties (Investors, Compensation Scheme Ltd v West Bromwich Building Society [1998]). The parties had already been in a long contractual relationship and knew that the salons were in operation through limited companies of which GF was a director and shareholder and that GF acted as its agent. The court concluded that, given the factual background and the common understanding that a covenant binding on GF only in respect of acts done on her own behalf (rather than as agent for another) would have been ‘toothless’.
Clause 7.1.2 must be construed in the only way that was commercially sensible - as prohibiting GF from canvassing, soliciting, enticing or employing any of the named individuals whether on her own behalf or as agent for another. The employment of LH and CH before October 2015 therefore breached clause 7.1.2 and Rush had been entitled to withhold the deferred consideration of £15,000.
By subsequently entering into the consultancy agreement with JT, as agent for SJF, GF also breached clause 7.1.2. It was accepted that engaging JT on a self-employed basis fell within the meaning of ‘employ’ in the clause. The objection had been that it was SJF that employed JT not GF. However, on the evidence GF did not breach clause 7.1.2 by canvassing or soliciting JT, as JT approached GF for work and not the other way round.
Non-compete covenant (Clause 7.1.3)
Despite the SPA lacking a definition of ‘Rush business’, the court thought it was clear from the SPA as a whole that this meant Rush’s hairdressing business and rejected the arguments on behalf of GF and SJF that, on a narrow interpretation, it could be interpreted as meaning the use, sale and promotion of hair products alone. The Deputy Judge concluded, therefore, that the covenant prevented GF from being involved in a business ‘similar to or which competes with’ Rush’s hairdressing business within a two mile radius of the Windsor and Maidenhead salons.
It was not disputed that by setting up SJF, GF had acted contrary to clause 7.1.3. The issue was enforceability. In relation to geographical reach, the court concluded that the Territory was reasonable given GF’s personal reputation and given that the aim of the covenant was to prevent GF from operating anywhere in Windsor. Rush was entitled to take the view that Windsor was a small town and that loss of customers would occur if GF relocated to any part of Windsor. As to duration, the relevant principles were the same as were applicable to clause 7.1.2. The period was not out of keeping with those upheld in other vendor-purchaser agreements and the Deputy Judge had no reason to doubt that, given GF’s reputation, there would be some real loss of business to Rush if GF opened a competing salon during the second year of the period. Clause 7.1.3 imposed a restriction that was reasonable and, in principle, enforceable.
Comment
The judgment is a useful reminder of how restrictive covenants in share sale and business sale agreements should be interpreted, particularly where there is ambiguity, and when the court will look behind the corporate veil at the ‘real actors’ following Petrodel.
Note, however, that both of the covenants in question omitted some key wording which, had it been included, would have made them more effective and less open to challenge in the circumstances of this case.
