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Restraints in Shareholders Agreements: How Valuable are They?

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Shareholders often include restraint provisions or restrictive covenants in their shareholders’ agreement which aim to protect the company’s business and proprietary interests by seeking to ensure that each shareholder, whilst still a shareholder of the company and for a certain period thereafter, will not conduct business which is in competition with the business of the company or attempt to solicit clients, suppliers or employees of the company away from the company. Including such restraints recognises that, by virtue of a shareholder’s relationship with the company, and particularly where the shareholder is also a director of the company, such shareholder will acquire in-depth knowledge and know-how regarding all aspects of the company’s business and that should that shareholder then use such knowledge or know-how for his own benefit or the benefit of a competitor, the company may suffer considerable financial loss and/or loss of market advantage.

In South African law, these restraint provisions are generally enforceable unless they are found to be unreasonable and contrary to public policy. In order to determine their reasonableness, a court would look at factors such as the time period of the restraints, the geographical areas to which the restraints apply and the proprietary interests which require protection by the company. Assuming that the restraint provisions in a shareholders’ agreement are well drafted and are reasonable enough to ensure their enforceability, how valuable can they be in protecting the company from the actions of a rogue shareholder?

The High Court case of Big Catch Fishing Tackle Proprietary Limited and Others v Kemp and Others (17281/18) [2019] ZAWCHC 20 (5 March 2019) illustrates the effect of not including restraint provisions in a shareholders’ agreement. In this case, the non-breaching shareholders (the “Applicants”) sought to interdict a fellow shareholder, who had resigned as a director of the company but remained a shareholder, from, amongst others, approaching or contacting any of the company’s clients, service providers and suppliers for the purposes of his own competing business. As the shareholders’ agreement did not include any restraint provisions, the Applicants contended that their fellow shareholder’s fiduciary duties as a director of the company continued after his resignation and that these would prohibit him from such actions and from carrying on his own business activities in competition to those of the company. The court found that, while certain fiduciary duties may continue post the termination of a director’s directorship, a former director is still entitled to continue to earn a living by setting up other businesses, even if these are in competition with the business of his former company (provided of course, that in doing so he does not breach those fiduciary duties which do continue after his resignation, such as those relating to the use of the former company’s confidential information and trade secrets). The court therefore dismissed the application for the interdict. Further, the court considered whether the “good faith” provision in the shareholders’ agreement could be relied upon to prohibit the shareholder and former director from carrying on his competing business. In this regard, it found that the “good faith” provision applied only for so long as the parties actively ran the company and therefore could not be relied upon in the circumstances.

The Big Catch Fishing Tackle case confirms that without restraint provisions in a shareholders’ agreement, it would be very difficult for shareholders to protect the company’s business and proprietary interests from a shareholder seeking to compete with the company. Where such restraint provisions have been included in the shareholders’ agreement, shareholders who suspect or find that a fellow shareholder has or is likely to breach the restraint provisions could look to various protections. Firstly, they could consider whether to approach the court for an interdict to enforce the restraint and therefor stop the offending shareholder from embarking on or continuing with his potentially damaging course of action. As a starting point, the non-breaching shareholders would need to be certain that the restraint provisions are, in fact, reasonable enough to be enforceable. The non-breaching shareholders would also need to comply with the requirements for the granting of an interdict, including being able to show that, should the interdict not be granted, the breaching shareholder’s actions would cause the company irreparable damage.

In addition, the non-breaching shareholders could assess whether the shareholders’ agreement also included a deemed offer provision which could be relied upon to force the breaching shareholder out of the company. Such a deemed offer provision would typically provide that, in the event that any shareholder breaches the shareholders’ agreement (including the restraint provisions), the breaching shareholder shall be deemed to have offered his shares to the non-breaching shareholders at a certain price, often being a discount to the fair market value in order to penalise the breaching shareholder for his behaviour. In this way, the non-breaching shareholders could force the breaching shareholder’s exit, thereby stopping his continued access to the company’s proprietary interests. Whether or not an applicable deemed offer provision is included in the shareholders’ agreement, the non-breaching shareholders could also be entitled to various remedies for breach of contract, including a claim for damages suffered by the company as a result of the breaching shareholder’s actions.

In practical terms, enforcing restraint provisions in a shareholders’ agreement can be problematic where it is difficult to prove that a fellow shareholder has, in fact, breached the restraint provisions or that the fellow shareholder’s actions do indeed fall within the ambit of the restraint provisions (for example, that his actions are within the time periods and geographical areas stipulated therein). However, without restraint provisions in a shareholders’ agreement, shareholders have limited remedies in protecting the business of the company from a competing shareholder. Without a doubt, including well drafted restraint provisions in a shareholders’ agreement can be valuable in protecting the company and its business from the very people who have often helped to build it.

Sarah Van Zyl

Sarah has a BA (Law and Psychology) and LLB (cum laude) from Wits. She was admitted as an attorney in 2010 after having completed her articles at ENS and is a qualified solicitor in England and Wales (non-practising). Sarah practiced as an associate in ENS’ corporate commercial department before going in-house at Investec Bank plc in London. She joined Caveat in 2018, specialising in corporate and commercial work.

 

 

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