Restraint of Trade – Quantum Advisory Ltd

In Quantum Advisory Ltd v Quantum Actuarial LLP [2020] EWHC 1072 (Comm), the High Court considered whether the restraint of trade doctrine applied in a services agreement entered into in connection with a restructuring and joint venture. The court decided that it did not.

What is a restraint of trade clause?

The purpose of a restraint of trade clause is to restrict the freedom of a business or individual to pursue their trade with the effect of limiting competition.

The case Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC 535 serves as an illustrative example.

Thorsten Nordenfelt, a manufacturer specialising in armaments, had sold his business to Hiram Stevens Maxim for £200,000. They had agreed that Nordenfelt ‘would not make guns or ammunition anywhere in the world, and would not compete with Maxim in any way for a period of 25 years’.

The House of Lords held that the restraint was reasonable in the interests of the parties. They placed emphasis on the £200,000 that Thomas Nordenfeldt had received as full value for his sale.

The restraint of trade doctrine

The restraint of trade doctrine exists to protect a party to a contract that is subject to a restraint of trade clause i.e. the party who has been restrained in their trade by the contract. Therefore, when the doctrine applies, the restraint of trade clause in question will be invalid. The doctrine states that a restraint of trade clause will be invalid unless it is:

1. Designed to protect a legitimate business interest.
2. No wider than reasonably necessary to protect that interest.
3. Not contrary to the public interest.

How does the restraint of trade doctrine apply?

There is a line between contracts in restraint of trade, within the meaning of the doctrine, and ordinary contracts that merely regulate the commercial dealings of the parties. The courts will consider, first, if the contract in question is in restraint of trade and, secondly, whether in all the circumstances sufficient grounds exist for excluding the contract from the application of the doctrine. The recent case of Quantum Advisory Ltd v Quantum Actuarial LLP [2020] EWHC 1072 (Comm) allowed a judge to explore both of these questions in depth.

Quantum Advisory Ltd v Quantum Actuarial LLP [2020] EWHC 1072 (Comm)

Facts

In 2004, a company called Quantum (Old Quad) entered into a joint venture with Robert Davies (RD) and others. A new company (RDS) was set up to carry on a similar business with different clients. The single largest shareholder and the MD of Old Quad was Martin Coombes (MC). The principal shareholders in RDS were Old Quad and RD. It was intended that after an initial three-year period there would be a merger of the businesses of Old Quad and RDS into a single entity.

By 2007 however, the interests and ambitions of those involved had begun to diverge. In particular, while MC wanted to diversify, the other directors and shareholders wanted to focus on developing the existing business. For this and other reasons, a restructuring of the businesses became necessary. One problem this presented was that MC’s shareholding in Old Quad was such as to make it unaffordable for the other parties to buy him out. It was also felt that, regardless of affordability, it would be very difficult to fix a price for any buy-out.

The restructuring

A way of getting round these problems was devised, by which:

• The businesses of Old Quad and RPS would be carried on by a new entity (the LLP).
• A company wholly-owned by MC (New Quad) would buy the entire issued share capital of Old Quad and RPS. The businesses and assets of those companies would be transferred to New Quad subject to outstanding liabilities.

The terms of the restructuring were documented by way of an agreement dated 1 November 2007 entered into between Old Quad and the LLP (Services Agreement). Among other things, the Services Agreement:

• Contained covenants on the LLP’s part (clause 2.2) to not during the course of the Services Agreement or for a period of 12 months after its expiration or termination directly or indirectly:
  • solicit or entice away (or attempt to solicit or entice away) any Client in connection with any Services;
  • obtain instructions for any Services from any of the Clients or undertake any Services for any of the Clients; or
  • undertake any Services in relation to either the Pipeline Business or any work introduced by any of the Introducers during the Extended Period, without first having referred such matters to Old Quad, other than pursuant to the provisions of the agreement.
• Contained acknowledgments to the effect that:
  • The provisions of clause 2.2 were no more extensive than was reasonable to protect the interests of Old Quad.
  • Each of the restrictions in clause 2.2 was a separate obligation considered reasonable by the parties (each of them having taken, if required, separate legal advice) in all the circumstances as necessary to protect the legitimate interests of the other party (clause 2.6).

Business affairs prior to litigation

New Quad and the LLP conducted their affairs according to the Services Agreement without any real difficulty for a number of years. Increasingly, however, the LLP became dissatisfied with the terms of the Services Agreement. The LLP sought to contend that the restraints in the covenants in clause 2.2 amounted to an unreasonable restraint of trade. Specifically, it complained about the duration of the restraints in circumstances in which the LLP had very limited ability to extricate itself from the Services Agreement before expiration. The LLP did not otherwise complain about the duration of the Services Agreement or the nature of the covenants themselves.

That led to New Quad commencing proceedings, seeking a declaration that the Services Agreement was binding on the parties and an injunction to restrain the LLP from acting in breach.

Decision

The judge concluded that:

• The doctrine of restraint of trade did not apply to the restraints and therefore the restraint of trade clauses were legally enforceable.
• If the doctrine of restraint of trade had applied to the restraints, he would have found that they satisfied the requirement of reasonableness.

Did the restraint of trade doctrine apply to the restraints?

In concluding that the doctrine did not apply to the restraints, the judge was at pains to stress that the Services Agreement needed to be considered on its own terms and in its own circumstances. It was a bespoke agreement, fashioned to address the competing needs and interests of a group of professional people. In his opinion the following considerations weighed against the application of the doctrine:

• The fact that the LLP had been brought into existence for the purpose of the restructuring that was effected via the Services Agreement. It had no prior being or business and no other rationale. While it was true to say that its trade was restrained by the Services Agreement, this argument lacked the kind of traction normally found in restraint of trade cases. In a sense, the Services Agreement was the essential condition of the LLP’s ability to carry on business at all. It was not a restraint of trade but a means of providing the opportunity to trade.
• In this light, to attempt to place the covenants in clause 2.2 of the Services Agreement within the scope of the restraint of trade doctrine showed up a degree of incoherence. The judge pointed out that:
  • To view the restraints as potentially justifiable if of shorter duration (a view which counsel for the LLP had at one point expressed) was to divorce them from the wider agreement and so mistake their nature. Their purpose, as MC had phrased it in a witness statement, “was to recognise the legacy/LLP client ownership boundaries”.
  • It had originally been proposed that the term of the Services Agreement be ten years. However, the members of the LLP had expressed concern that, if the agreement ended after ten years, the LLP’s sustainability would be threatened by the loss of a major part of its business and income so soon after trading had commenced. When MC proposed extending the term of the agreement to 99 years, the LLP agreed.

Would the restraints have been regarded as reasonable?

The following factors were among those that led the judge to conclude that, had the doctrine of restraint of trade applied to the restraints, he would have found that they satisfied the requirement of reasonableness:

• The fact that the Services Agreement and the restraints were a matter of free agreement between experienced, intelligent, articulate and highly competent business people who were able to look after their own interests and who had expressly agreed that the restraints were reasonable as being necessary to protect the parties’ interests.
• The LLP had not persuaded the judge that the restraints were unreasonable on account of any consideration of public policy.

The judge dismissed the argument based on alleged:

• Inequality of bargaining power between the parties (and indeed the alleged lack of any formalised negotiation process at all) because this was not supported by the facts. While it was true that the LLP had not received independent legal advice in connection with the Services Agreement, the judge did not regard this as indicating that the parties’ free agreement ought to be viewed with particular caution when considering reasonableness. There was no obligation to seek independent legal advice, under clause 2.6 of the Services Agreement or otherwise.

Context is essential

Clearly this is a decision that turned on the facts. Since most reported restraint of trade cases in the corporate arena arise in relation to private M&A it presents a rare opportunity to see how the courts construe the restraint of trade doctrine in a different context. The decision is a reminder that not all restrictive covenants are subject to the restraint of trade doctrine and the specific business context is crucial to such a ruling.

If you have any questions about restraint of trade clauses or about contract law more generally please contact Neil Williamson.