The importance of drafting reasonable and proportionate clauses in an agreement was highlighted in the recent case of El Makdessi v Cavendish Square Holdings BV and another in which the Court of Appeal considered whether clauses in a share purchase agreement were unenforceable penalties.

In February 2008 Mr Talal El Makdessi, a key figure in the Middle Eastern advertising and marketing world, sold part of his advertising group to Cavendish Square Holdings BV (C BV), retaining a 20% shareholding.

The share purchase agreement (Agreement) contained extensive restrictive covenants prohibiting Mr Makdessi from competing with the group following the sale.

The consideration for Mr Makdessi’s shares was to be paid to him in various instalments linked to the group’s operating profits, and the Agreement also contained provisions catering for the subsequent purchase by C BV of Mr Makdessi’s remaining shares.

The Agreement provided that, if Mr Makdessi was in breach of his restrictive covenants, C BV would be:
(a)    released from its obligation to pay the outstanding deferred consideration; and
(b)    entitled to force Mr Makdessi to transfer the remainder of his shares in the company to C BV at a price based on net asset value (being a less advantageous price than Mr Makdessi would have otherwise been entitled to receive).

After the sale C BV claimed that Mr Makdessi had breached the restrictive covenants and sought to enforce the provisions set out at (a) and (b) above. Mr Makdessi argued that the clauses were unenforceable as the effect of the clauses was to deprive him of up to US$115 million in circumstances where C BV had suffered no losses recoverable at law, therefore being disproportionate and unreasonable.

At first instance the Courts ruled in C BV’s favour however, the Court of Appeal unanimously reversed that decision. The Court of Appeal held that the clauses were extravagant and unconscionable with a predominant function of deterrence rather than there being any commercial justification for the clauses.  For the clauses to be reasonable and proportionate, they would have needed to include a genuine pre-estimate of C BV’s loss, rather than being penal.

The findings in this case not only serve as a reminder that a careful approach is needed when drafting clauses dealing with a seller’s non-compliance with non-compete or similar covenants following completion of a transaction, but should also serve as a general reminder that the Courts are looking for parties to adopt a reasonable and proportionate approach on restrictive covenants generally.

For any advice on corporate law matters such as share purchases, or business sales/purchases, please contact us. Our corporate law solicitors would be happy to advise you.