What are Restraint of Trade Clauses and are they Legal?

The general principle in the UK is that individuals should be able to follow their trade and use their skills without undue restriction imposed on them by others. Likewise, businesses should be free to compete with other businesses.

What is ‘restraint of trade’?

A restraint of trade condition is a restriction imposed on free trade, or a condition limiting an individual’s liberty of traders to buy and sell freely.

How are restraint of trade clauses imposed on parties?

Restraint of trade clauses are contractual clauses imposed on an individual of business. For instance, one may be imposed by an employer to restrict or prevent an employee moving to a competitor after they leave, or restricting their activities when they leave.

Restraint of trade clauses are also commonly found in sale/purchase agreements (SPAs) to limit the activities of a seller to act in competition with the business sold after completion. For instance, the buyer may wish to prevent the seller entering the same type of business in the same geographical location for a certain period of time.

However, competition law acts to ensure that traders are free to select with whom they contract without restriction by other business organisations. For this reason, any clauses which seek to restrain the right of business, traders or individuals will be unlawful and void – unless it is reasonable and in the public interest, and extends no further than necessary to protect the legitimate buyer’s business interests.

When are restraint of trade clauses allowed?

The general rule is that restraint of trade clauses are unenforceable at common law. However, a court may decide to enforce a restraint of clause if it is considered to be reasonable, with reference to the interests of both parties, and it does not breach the public interest in free trade. Therefore, restraint of trade clauses must be no more than is necessary to protect the legitimate interests of the party relying upon it.

In considering whether to allow such a clause, the court will take into account a number of factors, including looking at the terms of the contract itself. For example, the court will consider whether the party subject to the clause has been sufficiently compensated for that restraint. It may also look at industry practice and other similar contracts within the industry.

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

How do restraint of trade clauses work in the employment sector?

Restraint of trade clauses in the context of employers aim to protect a business’s goodwill and trade secret. A restraint of trade clause may, therefore, be imposed to prevent an employee, director, partner, etc. leaving and immediately joining a direct competitor. Such a clause may impose a time period during which the person may not join a competitor, and/or impose a geographical area in which they may not work for a given time.

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

An employer cannot protect its business from competition in a fair and open market. However, an employer is lawfully able to protect itself against the unfair exploitation of its legitimate interests by an employee by relying on restraint of trade clauses.

Therefore, restraint of trade clauses in the employment context are lawful only if:

  • It protects a legitimate business interest
  • It extends no further than reasonably necessary to protect that interest

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

Legitimate business interests can include the following:

  • Relationships with clients
  • Connections with third parties who may be essential to the business, such as suppliers and consultants
  • 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. For example, restricting a geographical area within which the ex-employee may work to a 100-mile radius may not be reasonable, but a 10-mile radius may be reasonable.