Restrictive covenants in investment agreements: Enforceability issues

In a recent High Court ruling, Literacy Capital Plc v Webb, the court has dismissed an application for an interim injunction aimed at preventing a manager of a private capital-backed business from breaching restrictive covenants.  

The injunction was sought by Literacy Capital Plc, an investment company which controls Mountain Healthcare (amongst other investments), against Vanessa Webb, a former director of Mountain Healthcare having built up the business before its sale to Literacy Capital in 2018.

As noted below, this case serves as a critical reminder for private equity, venture capital and other institutional investors: the courts will carefully scrutinise, and potentially invalidate, overly restrictive covenants within investment agreements. The judgment underscores the importance of ensuring such provisions are reasonable in scope and duration, and tailored for the specific employee to whom they apply, to align with legal standards regarding restraint of trade.

Background facts

As part of the sale to Literacy Capital in 2018, Webb and Literacy Capital entered into an investment agreement and loan agreement (under which c.£4.5m of deferred consideration for the sale of her shares would be paid to her under a loan). In 2021, she resigned from Mountain Healthcare and renegotiated the terms of both agreements. The loan she had given was extended in the form of loan notes, payable on the earlier of 28 October 2028 (later extended to 2030) or a sale or listing of the business. 

The 2021 investment agreement contained restrictive covenants preventing her from competing with Mountain Healthcare until 12 months after the redemption of Webb's loan notes. The application for the injunction centred on those covenants. They sought to prevent Webb from competing with Mountain Healthcare's business within the UK and Channel Islands, and applied (by remaining in place until 12 months after the loan notes were redeemed) for up to 10 years. 

After leaving Mountain Healthcare, Webb set up another healthcare business, Nurture Health, which operated in a different sector. After the end of a 12 month ex-employee non-compete, Nurture Health began to develop services in the same sector in which Mountain Healthcare operated. It won a contract providing services very similar to those of Mountain Healthcare in 2024, to a customer which operated in a similar field to customers of Mountain Healthcare. Literacy Capital brought a claim for breach of the 2021 investment agreement covenants against Webb, and sought an interim injunction to prevent the competing activities from continuing.

Outcome from the judgment

The injunction was refused. While the judgment considered that it is not usually appropriate for the court to assess the enforceability of a restrictive covenant at the time of an interlocutory (ie pre-trial) injunction, it made an exception in this instance due to what the judge perceived as being clear issues with validity.

Under English law, a covenant which restrains trade will be unenforceable unless the party relying on it can establish that the restraint is reasonable.  When determining reasonableness, the courts will consider the extent or scope of the covenant in relation to the areas of trade or service restricted, the geographical area covered and the duration of the restriction, as well as whether a narrower covenant would have sufficed. The type of work which the individual was doing is also directly relevant when assessing the scope of the restriction.

In this case, the covenants were considered as being void and unenforceable on the basis they were: 

• overly broad, applying on a nationwide basis in respect of a wide range of services (in respect of which, Literacy Capital had not submitted any evidence that Mountain Healthcare had customers nationwide or carried out any of those services)
• of excessive duration (extending beyond the typical length of covenants for ex-employees or a vendor in the context of business sales), and 
• in contravention of public policy against restraint of trade (as the covenants had clearly been given in the context of Webb's expertise in growing, and her role as a key employee and director of, Mountain Healthcare). Consequently, the claimant could not present a credible argument that the covenants restrictions were reasonable or enforceable under common law.

As a result, the covenants were judged to go far beyond protecting Literacy Capital's legitimate interests in buying Mountain Healthcare and protecting the goodwill received in that business.  The continuing application of the covenants during the period Webb would hold the loan notes and for 12 months afterwards (potentially up to 8 years from the loan notes being issued, subsequently extended to 10 years) was a key factor in the court finding that the covenants were excessive and refusing to allow the application for an injunction.