Individuals should be able to use their skills without undue restriction and businesses should be free to compete with other businesses. However, restraint of trade clauses are not uncommon within commercial contracts. This blog considers the general principles of restraint of trade and examines the different types of restraint of trade clauses that you may come across in your commercial dealings.
What is a restraint of trade clause?
A restraint of trade clause is a contractual restriction imposed upon a business or an individual for a finite period of time. The purpose of a restraint of trade clause is to protect a business interest. In the employment context, restraint of trade clauses are usually used to prevent employees or directors leaving and immediately joining a direct competitor. However, in the commercial context, restraint of trade clauses can be much wider reaching. A restraint of trade clause in a Share Purchase Agreement may, for example, limit the activities of the seller to act in competition with the business sold after completion. Due to the general principle that individuals and organisations should be free to carry on their business however they see fit, restraint of trade clauses are generally unenforceable at common law. However, a court may decide to enforce a restraint of trade clause if it:
- is designed to protect a legitimate business interest;
- is no wider than is reasonably necessaryto protect that interest; and
- is not contrary to the public interest.
If these criteria are not met, the restraint of trade clause will be void and unenforceable. If these criteria are met, the clause will usually stand up in court. But what exactly do each of these criteria mean?
What are legitimate business interests?
The first task when drafting a restraint of trade clause is to make sure that you understand the nature and extent of the interest requiring protection. Although the categories of legitimate business interests are not closed, the most common legitimate business interests include:
- Business relationships with clients
- Goodwill of a company
- Trade connections
- Trade secrets and other confidential information
Is the restraint reasonable to protect that interest?
Once a legitimate interest has been identified, the restraint of trade must go no further than is necessary to protect that legitimate interest. The restraint must be reasonable as to the term of the restriction, the geographical area, and the scope of the activities covered. The term “reasonable” is generally taken to mean providing no more protection than is relevant and necessary to safeguard the relevant legitimate interest. With geographical area, for example, a restriction on a seller who operated solely in the UK from operating a similar business anywhere in the world would probably be unreasonable (although would depend on the type of business). With the term of the restriction, it is much harder to lay down a general rule. However, the courts do acknowledge that the longer the term of the restraint, the greater the chances are that it will be found unreasonable. Having said that, it is not unheard of for restraint of trade clauses in commercial contexts to last for 2, 4 or even 5 years.
In Esso Petroleum Co Ltd v Harper’s Garage, Lord Hodson stated that in the case of agreements between commercial parties, the parties are usually taken to be the best judge of what is reasonable between themselves, meaning that the courts will be slow to interfere and find a restraint unreasonable. This also means that what might be reasonable in one context might be unreasonable in another. The burden of proof will be on the person enforcing the clause to show that the restraint goes no further than is necessary to protect the legitimate business interest.
Is it contrary to the public interest?
In the majority of cases, if a restraint of trade is reasonable between the parties, the courts will try to uphold it. However, on occasion, the courts will consider a restraint of trade from the perspective of “public interest” rather than that of the parties. Although it may crop up in the employment context, public interest is far less likely to be relevant in contracts between commercial parties. More relevant in the commercial context nowadays may be the interest of customers that under UK and EU competition law, competition is not unduly restricted.
Different types of restraint of trade clauses
It is important to note that there are many different types of restraint of trade clauses. The type of clause you choose will depend upon the type of agreement you’re drafting. A sale and purchase agreement, for example, would typically contain restrictions on the sellers from soliciting existing customers or suppliers, soliciting existing employees, or competing with the business for a specified amount of time. A typical franchise agreement would contain restrictions on the franchisee applicable during the lifetime of the agreement and usually for a limited period thereafter. Typically, these would be not to solicit customers or employees, not to compete with the franchise business and not to represent themselves in any way connected with the franchisor. Non-solicitation and non-compete clauses are the most common types of restraint of trade.
What happens if the restraint of trade is found to be unreasonable?
Where a restraint of trade clause is found to be unreasonable, it will be void and unenforceable. A court is unlikely to enforce a restraint of trade clause if the restrictions are inappropriate for the role, excessively long or entirely ambiguous. Where a restraint of trade clause is found to be unreasonable, the doctrine of severance may provide assistance. The doctrine of severance allows an unenforceable clause to be severed from the remainder of the agreement, with the remainder of the agreement remaining in force. Commercial parties will often include a severance provision in their contracts however this is not strictly necessary. The courts can apply the doctrine of severance without express authorisation in the contract. Nevertheless, it would be wise to include a severance provision in the contract to be safe.
Businesses do not have complete freedom when drafting and inserting restraint of trade clauses into their commercial agreements. If you are considering a restraint of trade clause in one of your commercial contracts, you should make sure that it complies with the above requirements. If you have any questions about restraint of trade, or about any other commercial or contract law issue, contact Neil Williamson.