Competition

Case Note: Emersub XXXVI Inc and Another v Wheatley

 

Yatoni Cole-Wilson

This case note first appeared on the Lancaster Buildings website in Nov 1998

Last updated 21 Dec 2005

This was an action for an injunction to restrain the defendant, Clement Trevor Wheatley ("Mr. Wheatley") from breaching or continuing to breach certain restrictive covenants contained in a deed of undertaking to the first plaintiff, Emmersub XXXVI Inc. ("Emmersub") that he entered on the 30th November, 1994 as part of an agreement to purchase shares that he and his family trust had held in the second plaintiff, Control Techniques Plc ("CT").

The Issues for the Court

Following directions by Alliott J for a speedy trial, the parties agreed to limit the trial to 3 specific preliminary issues, namely whether the restrictive covenants contained in the deed were:

	valid, reasonable and enforceable;
	supported by consideration and, if not, whether they are unenforceable on the basis that equity will not enforce a deed entered into without consideration by way of injunctions; and
	subsequently superseded by restrictive covenants contained in Mr. Wheatley’s contract of employment with CT dated the 22 March 1996.

The parties further agreed that the question of whether Mr. Wheatley had been wrongfully dismissed from his employment should be excluded from the first issue but not whether any such wrongful dismissal, if established, would affect the validity or enforceability of those covenants. Mr. Wheatley further agreed to submit to final injunctive relief in the terms of the covenants until their expiry on the 20th Dec 1998 should all three specific issues be determined against him.

The Facts

Mr. Wheatley was an electrical engineer. In 1973 he and two companions set up CT to design, produce and market electronic drives for electric motors. The venture prospered and Mr. Wheatley was appointed its first chairman. The company was subsequently floated on the Stock Exchange with a market capital of £11.5 million. Emmersub, a wholly owned subsidiary of Emerson Electric Company ("Emerson") in the United States of America, acquired just under 30% of CT’s issued share capital. Mr. Wheatley and his family trust held approximately another 5.3%.

On the 1 Dec 1994 Emmersub offered to buy the balance of CT’s issued share capital that it did not already own at a price of 525p for each 10p share. CT’s board recommended acceptance and the purchase was completed by the beginning of Jan 1995. As part of the transaction, Mr. Wheatley entered 4 deeds with the first plaintiff which required him inter alia to transfer his interest in CT’s business. One of those deeds imposed certain covenants not to compete, solicit or deal with its customers, or solicit or entice its employees, for a period of 4 years from the date that Emmersub’s offer became or was declared unconditional, that is to say, until 20 Dec 1998.

By clause 2 (a) Mr. Wheatley undertook not to:

"carry on, be employed or otherwise engaged, concerned or interested in any capacity (whether for reward or otherwise) in, provide any technical commercial or professional advice to or in any way assist any business which is or is about to be engaged in the design, manufacture, assembly, production, distribution or sale of the restricted products or any of them or the supply of the restricted service or any of them in competition with any (Emerson) Croup Company in any part of the world"

He also agreed not to solicit or canvas or accept orders from any customer of any company owned by Emerson who was negotiating or discussing doing business as at 20 Dec 1994 or at any time during the previous three years. He further agreed not to entice away any employee of any Emerson company who was such as at that date, or at any time during the previous 3 years. In consideration of his shares, Mr. Wheatley received £2,241,971 in cash and £8,617,213 in loan notes which he redeemed in Oct 1997 and he was re-appointed the chairman of CT.

 On 27 May, 1997, he was dismissed in circumstances that have given rise to a claim for wrongful dismissal. Some 6 months later, he bought a substantial shareholding in a company called Tyzack Precision PLC ("Tyzack"), and shortly afterwards became chairman of that company. He accepted that his purpose was to assist Tyzack to move into the business of electronic drives in competition with CT and admitted that his actions were in breach of the restrictive covenants if they were valid and enforceable.

The Judge’s Approach
Wright J decided to address the preliminary issues in the following order:

	Were the restrictive covenants supported by any consideration and, if not, were they unenforceable either in law or in equity?
	Were the restrictive covenants contained in the Emmersub deed subsequently superseded by restrictive covenants contained in Mr. Wheatley’s contract of employment with CT?
	Were the restrictive covenants valid, reasonable and enforceable against Mr. Wheatley by either of the plaintiffs.

Were the Covenants supported by Consideration?

The judge had absolutely no hesitation in finding that the covenants in the Emmersub deed were supported by consideration. Emersub’s offer of £11 million for the shares and Mr. Wheatley’s acceptance were specifically mentioned in the deed. The restriction began when the offer to purchase the shares became unconditional. Mr. Wheatley’s counsel conceded in argument that if the deed had recited the background against which this deed of covenant was being executed he would have found it extremely difficult to argue that the terms of the share transfer agreement were not incorporated into the deed of covenants. In reality, the background was well known to everybody concerned. Had Mr. Wheatley not been willing to enter into those covenants the purchase of his shares would never have gone through.

Which Covenants applied?

As for the second issue, Mr. Wheatley’s service contract contained restrictive covenants in very similar terms to those of the deed of covenant, but they were to expire only 12 months from the date of termination of that employment. He contended that it had been entered pursuant to a clause of the Emersub deed which contemplated his entering into a direct agreement or undertaking with an Emerson company whereby he would accept restrictions and provisions set out in that deed of covenants, with such amendments thereto in relation to products services area and period as such company or companies may reasonably require for the protection of its or their legitimate interests, provided that such restrictions and provisions as amended should not be more extensive than those set out in that deed He also relied on a provision of his service contract that any previous agreement subsisting between the parties would cease to have effect. The judge rejected that that submission because the service contract related specifically to "any former agreement relating to the Executive's employment". The Emersub deed had nothing to do with Mr Wheatley's employment with CT or any other Emerson company. Its subject matter, and the transaction in respect of which Mr Wheatley entered into restrictive covenants was the sale of his shares in CT to Emersub.

Validity of the Covenants

After reciting the well known passages from the speeches of Lord Herschell, Lord Watson and Lord MacNaghten in Nordenfelt v Maxim Nordenfelt [1894] AC 535, those of Lord Morris and Lord Parker in Herbert Morris Ltd v Saxelby [1916] AC 668 and the judgment of the Privy Council in Bridge v Deacons [1985] 1 AC 705 that a covenant in restraint of trade that could not be enforced in a service contract might nevertheless be valid in a contract for the sale of a business, Wright J considered that the restrictions were necessary for the protection of the plaintiffs:

"The very thing from which the new proprietors of CT desired protection was the prospect of Mr Wheatley, who had built up the business of CT from scratch into a very substantial public Limited Company, from going into direct competition with them. I am satisfied from the evidence that I have heard that Mr Wheatley would present a formidable competitor to any organisation engaged in the electronic drive business …….. Although not necessarily an expert in the high level of technology involved in electronic engineering of this calibre, I am satisfied from what I have been told that he has a deep and wide-ranging knowledge of the industry, and of the areas in which and the applications to which the technologies and techniques can be placed to the most profitable use. When they took over CT, I am satisfied that the Emerson Group of Companies had an entirely legitimate interest in preventing Mr Wheatley from competing against them and thereby diminishing the value of the goodwill of the Company for which they were paying altogether some £200 million."

The judge rejected Mr. Wheatley’s submissions that the restriction was too wide geographically - on the ground that the restraint was against competition with no specific geographical scope, though he made it clear that he might well have upheld a world-wide ban in view of the global nature of CT’s business – and too long on the grounds that the 4 year term was a compromise between the 5 years originally demanded by Emerson and the 3 years offered by Mr. Wheatley.

Mr. Wheatley also submitted that the plaintiffs could not rely on a covenant of a contract that they had repudiated and that the 12 months restriction in the service contract showed that the restriction was too long. His lordship rejected the first argument on the ground that the contract for the sale of the business was separate from the contract of employment and the second on the ground that different considerations apply to service contracts and in any case that contract was expected to expire after the 4 year term of the share sale agreement had expired.
Comment

This judgment highlights the difference in approach to the enforcement of a restrictive covenant in a contract of service and a contract for the sale of a business. This transaction is typical of many contracts for the sale of a business where it appears to be in the interests of both parties for the vendor to run the company, at least for a while. Too often, relations break down between vendor and purchaser particularly hen the purchaser is part of a large group with a different corporate culture. It would be unwise of purchasers of businesses to rely on this case as authority for imposing restrictions on executives that would not otherwise be justified because each case is to be understood on its own facts.

 

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