Two of the most valuable assets for a business are often its people and confidential information. 

Private equity backed businesses can be particularly vulnerable to senior employees leaving and then setting up in competition. And when an individual leaves a business there can be a temptation for them to also take confidential information (client lists, product pipelines, pricing information, business plans, and know-how being the typical hit list) and/or ignore restrictive covenants.

When a private equity company acquires the assets of another company, for example through a pre-pack, restrictive covenants and their effect following a TUPE transfer, are often overlooked as they are usually hidden in employment contracts, but identifying and enforcing these clauses is often crucial to maintaining the value of the newly acquired business. 

WHAT HAPPENS WHEN THERE IS A TUPE TRANSFER?

In broad terms, the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) comes into effect where there has been a business transfer or a service provision change.

When a pre-pack business is acquired there is usually a transfer of an undertaking, business or part of an undertaking or business; a transfer of an economic entity which retains that identity and to which employees are attached. 

In those circumstances it is likely that TUPE will apply with the effect that the transferee effectively steps into the transferor's shoes with regard to the transferring employees. All of the transferor's rights, powers, duties and liabilities under or in connection with the transferring employees' contracts pass to the transferee and any acts or omissions of the transferor before the transfer are treated as having been done by the transferee (regulation 4(2), TUPE).

WHAT DOES THIS MEAN FOR RESTRICTIVE COVENANTS?

The principle that restrictive covenants can transfer under TUPE was established some time ago, in Morris Angel and Son Ltd v Hollande [1993] IRLR 169, [1993] 3 ALL ER 569. The facts were: 

• Mr Hollande, a managing director of a company and its subsidiaries, was obliged, due to the terms of a restrictive covenant, for a period of one year after ceasing to be employed not to do business with any person, firm or company who had at any time during the one year immediately preceding his termination done business with the group.
• The business of the parent company of the group by which he was employed was sold to the claimant (Transferee). 
• Immediately after the sale agreement transferring the business, Mr Hollande was dismissed. 
• The Transferee then sought to enforce the restrictive covenant.

In effect, the court adapted the terms of the covenant to mean that it could be enforced by the Transferee against Mr Hollande if he had done business with anyone who in the previous year before his termination had done business with the undertaking transferred to the Transferee.  The Transferee was deemed retrospectively to have been the owner at the time of Mr Hollande's dismissal and the Transferee was therefore given the right to enforce the restriction. 

Recently, in P14 Medical Ltd v Edward Mahon [2020] EWHC 1823 (QB), [2021] IRLR 39, the court has maintained that stance by holding that the contract of employment (including the restrictive covenants) between Mr Mahon (employee) and the business that had been transferred took effect as if it had originally been made between the employee and P14 Medical Ltd (transferee). The court noted that:

1. The relevant restrictive covenants in the transferring employee's employment contract survived TUPE, therefore the balance of convenience favoured the granting of an injunction to the transferee, in relation to the (a) express restrictive covenants, and (b) implied obligation not to disclose or use trade secrets. 

2. If the matter went to a full trial, the transferee was likely to be successful as the express restrictive covenants were clearly part of the employment contract between the employee and the transferee, as transferred, were not an unlawful restraint of trade, and would likely be breached by the employee's new employment with a competitor of the transferee. 

3. The transferee would be successful in establishing that, post termination of employment, the proposed activities of the employee on behalf of his new employer would also breach his implied contractual obligation not to use or disclose trade secrets of both the transferred business and the transferee's business.

WHAT NEXT?

The court's position in P14 Medical shows that enforcement of a restrictive covenant is a powerful tool to limit the impact of senior employees leaving the business. Injunctions can be granted against employees who seek to unlawfully compete by failing to comply with their restrictive covenants. Thereby protecting the value of new business purchases.

When considering purchasing a business a potential purchaser should consider what restrictions are currently in place and whether they are enforceable. There can be a temptation to introduce new covenants at the same time as a TUPE transfer. However, this should only be done following specialist legal advice.  Otherwise, the buyer could be faced with more immediate problems, such as claims for constructive or unfair dismissal.