AFH v Baker: Drafting, enforceability and solicitation in restrictive covenants

The recent judgment in the case brought by AFH Independent Financial Services Limited  (AFH IFS) and AFH Group Limited against an adviser (Ms Baker) from one of their acquired firms, and the firm Ms Baker subsequently joined  (Regentia Lifestyle Planning Limited), serves as a useful reminder of some of the key issues facing firms who are investing heavily to acquire other firms which, whatever the structure, is essentially a purchase of the goodwill in the client relationships held by the acquired firm.

In this case, Ms Baker was an employed tax adviser and trainee financial adviser at the acquired firm. Soon after the acquisition Ms Baker switched to a self-employed financial adviser role at AFH IFS and entered into various agreements with AFH IFS accordingly, which included restrictive covenants stating what Ms Baker was and was not permitted to do with former clients of the acquired firm should she leave AFH IFS. Certain provisions of those agreements, including the restrictive covenants, were expressed to be entered into for the benefit of AFH IFS and other members of the AFH Group. Ms Baker then decided to leave AFH shortly afterwards, resulting in this dispute.

The judgment, whilst lengthy, leaves some gaps relating to the context in which the case was brought by AFH. There are still, however, several key takeaways from the case, in particular for acquisitive firms looking to protect their investment in the purchase of client relationships. Such firms may wish to review their approach to imposing covenants on advisers to ensure that they put themselves in the strongest possible position should they later need to rely on such covenants.

Summary of key points

• Covenants between one group company and an individual will not automatically be enforceable by other group companies, even if that is explicitly stated – careful consideration of both the drafting and relevant law is required;

• Consistent drafting is very important – any ambiguity is construed against the party seeking to rely on the provisions. If there is more than one contract between the relevant parties, ensure that they work together in a clear and unambiguous way or you may struggle to later rely upon their provisions;

• Non-dealing covenants are less likely to be held enforceable by the Courts than non-solicitation covenants. With all covenants, they must be no more onerous than is reasonably necessary to protect a legitimate business interest. That is always fact sensitive and taking the same approach in every case, whilst convenient, may not offer the best protection;

• The Court made some very interesting (even unusual) findings on what conduct constituted solicitation. AFH had expressly told Ms Baker to inform clients that she was leaving after she handed her notice in, and that was not deemed to be solicitation. If a client then made a clear decision to follow Ms Baker to her new firm, subsequent conduct by Ms Baker to facilitate that move was also not solicitation as the decision had already been made – those findings mean that garden leave should be a serious consideration as the range of conduct constituting solicitation may be interpreted very narrowly by the Courts;

• It is important for the party bringing proceedings to carefully plead different causes of action on which it may seek to succeed – in this case the judge noted that Ms Baker may have breached her duty of fidelity to AFH, but AFH had failed to plead that cause of action in the proceedings.

We take a look at these key points in more detail.

Group companies and covenants

The purchasing firm, if part of a group, should consider carefully which entity is contracting with the relevant individuals subject to covenants, and which other entities within the group may need to benefit from those covenants – in the AFH case, other entities in the AFH Group were unable to benefit from covenants in a contract entered into between AFH IFS and Ms Baker, notwithstanding that the contract was stated to be for the benefit of all AFG group companies and there was a third party rights clause.

This was because the self-employed adviser, Ms Baker, was also deemed to be a "worker" under employment legislation. This inability of group companies to rely on the covenants would equally have applied if Ms Baker had been an employee.

So, if it is important for other group companies to be able to rely on covenants, advice should be sought on this, and consideration should be given to ensuring that the engaging entity is the company that requires the protection of the covenants or whether the relevant group companies seeking to benefit from the covenants should enter into their own agreement with the individual concerned.

Drafting consistency

It appears that in this case the drafting across the different agreements entered into between Ms Baker and AFH IFS was not entirely consistent. For example, the same definition of "clients" was not used. Any ambiguity in the drafting will always be construed against the person seeking to rely on that drafting and so making the relevant obligations crystal clear is important.

Enforceability of covenants

The judgment went into detail on several issues around the enforceability of the relevant covenants entered into between Ms Baker and AFH IFS:

• Whilst Ms Baker joined AFS from an acquired firm, it was not reasonable to apply the same covenants to Ms Baker as had been applied to a seller of the acquired firm;

• If a contract contains a non-solicitation provision, that diminishes the need for a non-dealing covenant. This was surprising as it is common practice to include a non-dealing covenant alongside a non- solicitation covenant given the difficulty of policing the latter. Consequently, whilst many firms will seek to include both types of covenant, they should be clearly severable (so that if the non-dealing covenant is deemed unenforceable then the non-solicitation covenant remains effective) and the non-dealing covenant is more likely to be enforceable if it is shorter than the non-solicitation covenant;

• Here, a 12-month non-solicitation covenant in respect of clients with whom Ms Baker had had significant dealings in the previous 12 months was reasonable, a 12 month non-dealing covenant in respect of the same clients was not, and was therefore unenforceable;

What is solicitation, and proving it

The Court in this case heard detailed evidence from and relating to several of the individual clients who followed Ms Baker from AFH to Regentia, to determine whether Ms Baker had solicited those clients in breach of the relevant covenant. This process raised the following key points:

• AFH asserted that the number of clients that followed Ms Baker to Regentia was unusually high and "suspicious", and therefore must have resulted from solicitation, but failed to advance evidence to support the assertion that the level of lost clients was indeed unusual. The Court will clearly require evidence to support these types of assertion – the Court said that "suspicion" was not enough, there must be evidence that each client who left was solicited;

• In this case there was no evidence that AFH considered putting Ms Baker on garden leave and AFH explicitly told Ms Baker to tell that clients she was leaving AFH after Ms Baker had handed her notice in – the Court found that simply informing a client you are leaving is not solicitation. Alongside the Court's other findings on what constitutes "solicitation" this made it difficult for AFH to succeed in proving that solicitation had taken place in respect of many of the departed clients;

• Ms Baker asking a third party (in this case a solicitor) to tell clients that she is moving to what Ms Baker considers a firm more aligned with her values, and suggesting that those clients contact Ms Baker to discuss this further, did amount to solicitation and a breach of the covenant;

• if a client "expresses an interest" in moving with an adviser and the adviser responds to that in a way "calculated to obtain their business" that is solicitation because the client has not yet made a decision to move;

• however, this is crucial and important – if a client has already decided to follow the adviser, the Court in this case decided that further contact from the adviser to follow up on and action that decision that is not solicitation – so evidence that the client had already decided to move was regarded by the Court as crucial on the solicitation issue. This is a bold position taken by the Court in this case and clearly narrowed the scope of conduct included within "solicitation" that breached the covenant;

• the judgment is not 100% clear on this but indicates that much of the conduct of Ms Baker examined by the Court happened whilst she was still an employee (ie before she chose to switch to a self-employed role). The conduct could therefore have amounted to a breach of duty of fidelity by Ms Baker, but this was not pleaded by AFH and so was not considered by the Court;

• the Court placed some weight on the Ms Baker's intention (the Court found that Ms Baker wasn't sure to what extent she could contact and solicit clients, and took that into account). The clear inference is that you must plead very specifically and have clear evidence to prove solicitation;

• No finding was made by the Court on whether Ms Baker misused AFH's confidential information in speaking to clients – that issue is subject to a separate hearing as part of the same proceedings.