What are Restraint of Trade Clauses and are they Legal?

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 to trade freely.

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.

How are restraint of trade clauses imposed on parties?

Restraint of trade clauses are contractual clauses imposed on an individual by a 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 in opening a competing business 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.

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.

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 held to be 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; and 
  • 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; and 
  • 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 is unlikely to be reasonable, but a 10-mile radius may be reasonable.

July 2019

UK Supreme Court upholds non-compete clause in landmark judgment

The UK’s highest court has recently upheld a clause in an employment contract preventing an individual from working for a competing firm for six months, after finding that the elements which would otherwise have made it an unreasonable restraint on trade could be ‘severed’ so making the clause reasonable.

Tillman v Egon Zehnder Ltd 

A non-compete clause, also known as a ‘non-compete restrictive covenant’, is a clause in a contract of employment which prohibits an employee from competing with an ex-employer for a certain period after the employee has left the business. Other common restrictive covenants aim to prevent the ex-employee from soliciting or dealing with certain customers or key employees of the business after they leave.

Legally, the starting point for post-termination restrictions on employees is that they are void as a restraint on trade and contrary to public policy. Therefore, if the clause is challenged, the ex-employer must be able to show the court that the clause is designed to protect its legitimate business interests; and that it extends no further than is reasonably necessary to protect those interests.

In the Tillman case, the Supreme Court had to consider at length whether the disputed ‘interest in’ wording covered a shareholding of any size. It concluded that it did. It also ruled that preventing an individual from holding shares in a competing company was a restraint on trade, and therefore should be assessed as to its reasonableness in the same way as any other restraint on trade. Finally, it found that the breadth of the disputed clause was such that it could not be considered reasonable.

The Supreme Court then had to consider whether it was permissible to sever the unreasonable parts of the clause from the remainder, in order to uphold the rest of the clause. It found that it was. In doing so, it overturned a 1920 Court of Appeal decision preventing severance, which has been treated by the courts as authority on the point for almost 100 years.

The Supreme Court ruled that the test for severance was a three-part one. Firstly, the unenforceable part of the clause must be “capable of being removed without the necessity of adding to or modifying the wording of what remains” – what the courts call the ‘blue pencil’ test. Secondly, what remains of the clause must be supported by “adequate consideration”, or a fair bargain between the parties. Thirdly, removing the unenforceable provision must not “generate any major change in the overall effect of all the post-employer restraints in the contract”.

As all three tests were met in this case, the clause could be upheld once the ‘interested in’ wording was removed.

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