Enforcement of Shareholder Restraints

We were recently successful for a client in a fierce contest in the Supreme Court in enforcing a 12 month restraint on a shareholder working for a direct competitor contrary to the provisions in a shareholders agreement (LCR Group v Bell (2016) QSC 130).

It is commonly the case that shareholders in a company enter into written agreements which set out their rights and obligations. Shareholders agreements of this nature are designed to achieve a harmonious and profitable business operational environment with cooperation between the shareholders.

A well drafted shareholders agreement should, particularly where the shareholders are of a management or executive level contain restraints of trade, drafted to strike a balance between  achieving a harmonious and profitable business operational environment with cooperation between the shareholders, protection of the company interests, and protection of individual rights.

Recent decisions on the enforcement of restraints of trade in shareholders agreements point to a more commercial and contractual approach rather than the approach generally accepted by the courts when considering restraint of trade in an employment contract.

Restraints of trade in employment contracts are said to be void being contrary to public policy.

A well drafted restraint clause in an employment agreement will typically contain non-competition provisions, geographical and temporal restrictions.

The starting point as observed by McMurdo J in AGA Assistance Australia Pty Ltd v Tokody [2012] QSC 176 at 25 is that:

“A restraint of trade is void as contrary to public policy unless it is reasonable in the interests of the parties and by reference to the interest of the public: see Nordenfelt v Maxim Nordenfelt Guns & Ammunition Co Ltd, Amaco Australia Pty Ltd v Rocca Bros Motor Engineering Co Pty Ltd. As to the interests of the public, the onus is on the party which is subject to the restraint to establish that the restraint is harmful to the public: Herbert Morris Ltd v Saxelby.”

Restraints on post-employment activity contained in shareholders agreements indicate a different approach. Issues such as mutuality of obligations, legitimate business interests of the company, acknowledgements of independent legal and accounting advice, the risk of loss of client and customer connections and relationship, confidential information and reasonableness of the restraints are all relevant considerations.

In BDO Group Holdings (Qld) Limited & Anor v Sully [2015] QSC 166, Flanagan J considered and enforced a restraint imposed upon an accountant who became a party to a shareholders agreement and a party to an employment agreement when he sold his business into the applicants.

The restraint of trade in the shareholders agreement provided a non-competition restraint of trade which purported to restrain the respondent from engaging in any activity during the restraint period and within the restraint area which essentially competed with the business activity of the company, provision of similar services, inducing, soliciting staff or clients.

In dealing with the shareholders agreement, and Flanagan J observed that the respondent agreed to:-

  • Diligently and faithfully devote…attention to the business
  • To cooperate and use…best endeavours to ensure that the group successfully conducted the business
  • To give approval to make decisions that were required of it in good faith and in the best interests of the group and the conduct of the business as a commercial venture

Relevantly, the shareholders agreement contained an acknowledgment that the terms of the restraint were reasonable considering the interests of each party and went no further than was reasonably necessary to protect the interests of the other shareholders, the group and the business.

In the decision of Seven Network (Operations) Limited & Ors v Warburton (No 2) [2011] NSWSC 386, Pembroke J dealt with a restraint of trade involving a senior executive of the Seven Network in the context of restraints imposed under an employment contract and a management equity participation deed.

In a decision notable for its clarity and analysis of both factual and legal issues, Pembroke J found that the restraints imposed in the management equity participation deed should be enforced. In analysing the circumstances relating to entry into the management equity participation deed, the commercial background and experience was detailed exhaustively. In that case Mr Warburton was a person of considerable commercial experience, knowledge and acumen. His Honour also considered that the entry into the management equity participation deed by senior executives such as the respondent was an important factor in the venture capital company’s decision to invest in the company (an investment of approximately $690 million for a 50% economic interest). The transaction involved, through an equity participation plan, senior management being given a financial incentive to strive to maximise the value of the business. By this means, the interest of the investors and senior management were aligned. In an effective practical sense, they became “owners of the enterprise”.

The commercial rationale for the deed was also analysed and His Honour commented:

“It resulted in the participating executives becoming the holders of shares and options in SMG. By this means, they acquired a shared financial interest in the enterprise with KKR and Seven Network Limited. The MEP Deed was designed, amongst other things, to enhance the prospect of senior management staying together as a team. It provided each of them with an opportunity to achieve a generous return on investment that was disproportionate to the risk being undertaken. From the perspective of KKR and Seven Network Limited, the restraints on competition served to protect their investment. But they also served to ensure that the investment of each of the senior management participants was not undermined or devalued. The object of the restraints on competition was to reduce the risk of devaluation of the business by the departure of any executives to work for competitors: to reduce the risk of the misuse of confidential information by its provision to competitors: and to reduce the risk of dissipation or reduction in the customer connection of the business”.

His Honour found that on the facts of the case, there was no logical reason for denying the existence of a legitimate financial interest to support the restraints imposed.

His Honour also dealt with the provisions in the MEP Deed which contained an acknowledgement of reasonableness of the restraints imposed. His Honour said “this is possibly the most important single factor in determining whether the restraint period was reasonable at the time it was entered into. It does not of course absolve the court from reaching its own conclusion, but as Emmett J observed in Synavant Australia Pty Ltd v Harris (2001) FCA 1517 at 85:

“The matter involves the exercise of business judgment. For that reason, considerable weight should be attached to the period the parties themselves have selected.”

His Honour further pointed to the fact that in this case, Mr Warburton had obtained legal and taxation advice at the time of entry into the deed, had been to a presentation at which attention was drawn to it and the commercial rationale and purpose behind the restraint was explained to him and he obtained written legal advice which specifically addressed the clause. Those factors reinforced the appropriateness of placing weight on his agreement as to the reasonableness of the restraint.

In LCR Group v Bell (2016) QSC 130, Byrne J enforced a 12 months restraint on a manager and shareholder, after analysing the scope of duties of the shareholder and the business interests of the company, finding that the restraint was reasonable and valid where the company and the prospective employer were direct competitors, and “there was a significant risk of appreciable detriment to LCR’s commercial interests through misuse of LCR’s confidential information.”

Enforcing restraints of trade, whether in employment contracts, business sale agreements or Shareholders Agreements is never simple and usually involves complex and contested, factual and legal issues. Where there are significant risks of serious loss and damage occurring if the restraints are not enforced ,protective and urgent injunctions are well warranted.

If you have any reason to consider action on a restraint of trade, and require urgent advice, contact us for assistance.

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