Post-termination restrictions resolved

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Post-termination restrictions resolved

Our client was the director and shareholder in a media publishing agency. His relationship with the other two director shareholders had deteriorated.  He wanted to exit the agency and take his client list to a new agency.  He also wanted a fair price for his shares. We advised him on his exit from the agency.

Results

We negotiated the variation of post termination restrictions in his employment contract and shareholders agreement – this meant that our client was free to walk with his clients without fear of repercussions.

We also secured  the purchase of his shares in the agency at fair market value – this meant that the initial derisory valuation offered was replaced with a higher share value.

How we achieved the result

We advised our client on:

  • The potential breach of contract;
  • The consequences on termination of directorship; and
  • The best strategy to use to achieve his desired outcome.

Employment background

Our client joined the agency in 2007, bringing his clients with him. He was given 25% of the agency’s shares, subject to him entering into a shareholders agreement with the two existing director/shareholders.

Everything went smoothly for the first few years. However, as the digital media market changed our client felt the agency was not changing to keep up. Relationships between the director/shareholders then soured. Our client felt that:

  • Strategic decisions were not being taken;
  • Members of his team and other resources were being allocated to areas of the business without his consent; and
  • The other two director/shareholders were excluding him from decision making and undermining his position.

Breach of contracts

We advised that such behaviour could well be in fundamental breach of both our client’s employment contract and the shareholders agreement.

Post termination restrictions

Our client’s employment contract and shareholders agreement contained post termination employment restrictions. These covenants prohibited him from soliciting or dealing with clients for 12 months after termination of his employment as a director or exit as a shareholder.

Enforceability of the restrictive covenants

We advised that the covenants looked reasonable for his status and were  enforceable. A robust approach is likely to be taken by the courts in respect of covenants in shareholders agreements. Post termination restrictions in shareholders’ agreements can be more onerous, and still enforceable, than those in an employment contract

Implications on breach of a contract

If our client could establish that his employment contract and the shareholders agreement were terminated in breach of contract the covenants would become ineffective.

Risk in breaching a post termination restriction

The risk for any employee, director or shareholder who breaches any post termination restriction is the former employer or business applies to court for an injunction to prevent him from a continuing breach.

For example, if there was a breach of a covenant restricting the director from soliciting clients or joining a competing business he could be prevent by a court order from doing this.  Plus, ordered to pay not only his own costs but the other sides as well.

Forced sale of shareholding

The shareholders agreement also provided that if he resigned, or was dismissed for gross misconduct, he would be forced to sell  his shareholding in the agency at zero profit.

However, our review indicated problems with the drafting of the shareholders’ agreement which could be used to our advantage. The problem was there was no mechanism for the remaining shareholders to purchase his shares if his employment was terminated in breach of contract. There was also no provision for the agency to buyback his shares in a similar situation. This was a problem for the remaining shareholders. The draft deficiencies meant the remaining shareholders were not on secure ground.

It usually pays to review the documents carefully as it is not uncommon to find problems.

Minority shareholders’ rights

We argued that our client had a right and expectation to be involved in the management of the business. And, since our client was being side-lined, it could be argued that his rights as a minority shareholder were being unfairly prejudiced. The remedy for such prejudice is commonly the purchase of the minority’s shareholders shares at fair market value.

Strategic advice

Given the agency’s conduct our client had grounds:

  • To resign because of his employer’s breach of contract, claiming constructive dismissal; and
  • Argue that there had been a fundamental breach of his shareholders agreement, hence none his post termination restrictions were enforceable;
  • Claim that his rights as a minority shareholder had been unfairly prejudiced;
  • Require the purchase of his shares at fair market value.

However, such a course of action would almost inevitably lead to a lengthy and costly legal dispute. The outcome of such a dispute was uncertain. Even if our client was successful the likely level of damages was uncertain. .

Solution

We took a robust approach. We emphasised that it was in the interests of all concerned to resolve matters swiftly. Hence we sought to achieve a negotiated settlement. This we achieved.

The ambit of the restrictive covenants were agreed not to apply to clients he had brought to the business. In addition, using our share valuation expertise we negotiated the purchase of our clients’ shareholding at a commercial value. There was no discount applied for the minority stake he was selling. We also secured an ex gratia tax free lump sum payment.

Alex Kleanthous is a partner in the employment law team who has worked on a variety of employment cases involving directorships and share holdings in private companies. Securing a good outcome for a director shareholder is a specialist focus area for Alex who is able to blend the legal issues with the commercial reality.