What are restraint of trade clauses and will they ever be legal?

Restraint of trade

What is meant by restraint of trade?

In the United Kingdom restraints of trade are restrictions that have been imposed on free trade or limitations on the individual liberty of traders to buy and sell freely.

How are restraint of trade clauses imposed on parties?

Restraint of trade clauses are usually contractual clauses that go too far in limiting competition on the market. Under the proper functioning of competition law it is the policy of the law to ensure that all traders are free to select with whom they contract.

It follows that any clauses which seek to restrain this power and impede selection should be void on the grounds of public policy unless it is reasonable to do so and it is in the public interest.

When will restraint of trade clauses come into play?

Most restraint of trade clauses are contractual provisions which in most cases usually come in the form of restrictive covenants placed on a party which will be deemed to go too far in protecting the interests of one of the parties.

An example of this is when a business is purchased; the purchaser will often wish to prevent the vendor entering the same type of business in the same geographical location for a certain period of time. 

When will restraint of trade clauses be allowed?

The general rule regarding restraint of trade clauses is that they are unenforceable at common law. However, a Court may decide to enforce such clauses if they are considered to be reasonable with the reference to the interests of both of the parties and do not breach the public interest in free trade.

When will a restraint of trade be regarded as reasonable and not to breach the public interest?

When deciding as to whether restraint of trade clauses in a contract are reasonable and not in breach of the public interest in free trade the court will take into consideration a number of factors.

Accordingly the clauses in the contract must be no more than is necessary to protect the legitimate interests of the party relying upon it. No party is allowed simply to restrict competition because they may wish to they will need to show that it is required to protect their legitimate interests.

Issues of contractual consideration will also be looked at by the court – for example the court will look into whether the party that has been restrained has been paid enough for that restraint.

The claimant will also need to prove on the balance of probabilities that the clause is protecting their legitimate interests.

Are there any other factors which the court is likely to take into consideration?

The court is also likely to take into consideration the following other factors when deciding whether a contractual clause is a restraint of trade:

• Industry practice
• Other similar contracts within the same industry

What is an example of a restraint of trade clause being reasonable and necessary to protect the legitimate interests of the claimant?

Going back to the previous example of a purchaser of a new business wishing to impose a clause on the vendor stating that the vendor cannot operate a similar kind of business in the same geographical area may be regarded as necessary to protect the legitimate interests of the claimant as they have just bought the business from the vendor and if the vendor were immediately to set up a competitor it would stop the claimant getting the business of the ground.

What factors will be taken into consideration in this example?

For the restraint of trade to be reasonable it will depend upon the duration of the clause being imposed and the size of the geographical area. For example if the purchaser restricts the vendor from operating a similar business within 2 miles for 6 months commencing on the date of the purchase it is likely to be regarded as reasonable. However, if this restraint of trade restricts the vendor from operating within 7 miles for a period of 10 years it is unlikely to be regarded as reasonable. Accordingly the contractual clause is likely to be void on the basis of it being a restraint of trade.

Can restraint of trade clauses also operate in the employment industry?

Restraint of trade clauses seek to protect the goodwill and trade secrets of a business and accordingly will seek to prevent staff from one company being poached by a direct competitor. In this case contractual clauses may be inserted into an employment contract in order to ensure staff does not move to competitors.

When will these kinds of restraint of trade clauses be deemed legal?

Restraint of trade clauses in the employment context will be deemed legal in the following circumstances:

• Where the restraint of trade clause protects a legitimate interest of the ex-employer
• Where the restraint of trade clause extends no further than reasonably necessary to protect that interest

An employer legally cannot protect themselves against competition as that it is a specific requirement of a fair and open market. However, an employer can protect itself against the unfair exploitation of its legitimate interests by an employee.

What will be deemed to be legitimate interests in this context?

In this context legitimate interests can include the following:

• Relationships with clients
• Connections with third parties who may be essential to the business such as suppliers
• Employees
• Trade secrets
• Confidential information

What happens once a legitimate interest has been identified?

Once a legitimate interest has been identified the restraint of trade clause must also be proportionate to that interest in terms of duration and scope.