Restraint Of Trade Clause – Commonly Asked Questions

What Is A Restraint Of Trade Clause & When Can A Restraint of Trade Clause Be Enforced?

If you are purchasing a business or employing staff, you must consider how you can protect the value of your investment.

What if the former owner of the business you are intending to buy sets up the same business right next door to your new business? Perhaps you spend time and money training your employees who have the benefit of specific experience and access to your intellectual property, your ‘trade secrets,’ and your customers and suppliers. If these scenarios resonate with you, then it’s worth taking time to think about how you might better protect the goodwill in your business and your contacts and intellectual property. You may be able to protect your interests with a well-drafted restraint clause. This blog takes a peek at restraint clauses in commercial contracts and when and if restraint clauses are enforceable.

In commercial contracts such as business sale agreements, franchise agreements, share sale or shareholders agreements, ‘restraint of trade’ clauses are included to protect a party’s valuable commercial assets, and interests and to safeguard the goodwill of the business or company. A restraint clause can enable a purchaser to restrict when and where the previous owner of a business can set up a competing business.

A restraint of trade clause can set parameters around what former employees can divulge to competitors, whether they can strike up contracts with your clients and suppliers and where and when they can set up similar businesses once their contract with your business ends.

What Is A Restraint Of Trade Clause?

A typical restraint of trade clause is when the parties to a commercial contract agree to restrict a signatory’s future conduct in some way.  For example, when the contract terminates, one party agrees to forgo the right to set up in competition within a certain geographical distance or timeframe.

Simply put, a restraint of trade clause restricts a party from doing certain things or conducting business in specific ways. A typical a restraint clause in a business sale agreement would restrict the vendor from setting up a new competitive business within a specified area of the business premises or determined radius and for a defined period of time after completion of the business sale.

Restraint of trade clauses can also restrict or stop a party from:

• Disclosing or using confidential information or the business’ ‘trade secrets’;
• approaching a party’s, clients, contractors, customers, employees, and suppliers with the intention of gaining business or employment; and
• interfering with the relationship between a party and its customers, clients, suppliers, contractors, and employees.

Why Might You Need A Restraint Of Trade Clause?

The purpose of a restraint of trade clause is to protect a business’s interests and goodwill. Often when a business is sold, a substantial proportion of the value of the business will be attributable to existing customer, supplier and contractor or employee relationships.

If, after completion of the business sale, a vendor starts a competing business and takes clients, suppliers, employees or contractors with them, the value of the business purchased by the buyer may be substantially reduced, or entirely diminished.

A restraint seeks to prevent such diminution of the value of the business sold.

How Do You Enforce A Restraint Clause?

In Australia, on the face of it at law, a restraint of trade clause is void and unenforceable unless the party seeking to rely on it can prove that it is reasonable to protect their business interests.

Generally, broad restrictions will not be deemed to be reasonable or enforceable. Unless it can be shown that restraint of trade clauses is genuinely necessary to protect the commercial interests of the business, post-employment restraints are presumed to be invalid and unenforceable. The more senior the position that a person holds, the more likely it is that a reasonable restraint will be upheld.

If a party to a contract has breached a restraint clause, the other party can apply to the Court for orders to enforce the restraint.

In determining whether the restraint is reasonable, the Court will consider whether the party imposing the restraint has a legitimate interest that requires protection. The Court will consider the acts covered by the restraint clause, the duration of the restraint the geographical area of the restraint and the nature of the business.

For the court to find that the restraint is enforceable it must be:

Reasonable in terms of the geographic area

• • The court considers whether the restraint imposes an unreasonable restriction on operating within a geographic area. If the court finds that the geographic restriction is too onerous, then the court may find the restriction to be of no effect and void.
  • For example, if the restraint of trade extended to Australia, or the World in its entirety, then the court could make a finding of void and of no effect.

Reasonable regarding duration

• • If the restraint of trade purports to exclude a business owner from trading in the same business ever again, or for, 20 years, then this restraint is likely to be considered excessive and likely to be found void and of no effect.
  • In determining the relevant Restraint Period, the courts generally uphold periods of between three- and twelve-months’ duration.

Reasonable in terms of the parties’ interest(s)

• • The court would look to whether a restraint was applied to protect a ‘legitimate interest’ or whether the restraint is too onerous. If the court finds the restraint to be too broad or too weighty, then the court would find that the restraint clause is unenforceable.
  • If, for instance, the restraint clause prohibited the previous business owner or former employee from conducting any business at all, then that would be held to be unreasonable because it reaches too far beyond safeguarding the legitimate interests of the purchaser or former employee.
  • If the restraint clause is constructed in such a way that it safeguards the reasonable interests of the purchaser such as the business’ goodwill or trade secrets, then it is more likely that the court will uphold the restraint clause and enforce it.

Reasonable in the public interest

• • If the court finds that the clause is unreasonable in terms of the public then the court may find that the clause is void and therefore, unenforceable. In Buckley v Tutty (1971) the High Court stated that:
    

    “Unreasonable restraints are unenforceable as it is contrary to public welfare that a person should be unreasonably prevented from earning a living in whichever lawful way he chooses, and that the public should be unlawfully deprived of his services.”

If the Court considers that the restraint clause affords sufficient protection and goes no further than is necessary to protect the interest of the parties and is not against the public interest, it will be reasonable and enforceable. However, if the Court finds a restraint clause to be unreasonable, it will be void and therefore, as a business owner or employer you cannot rely on enforcement.

Unsure Of How You Can Best Protect Your Commercial Interests?

Whether you are purchasing a business, planning to employ additional staff members, safeguarding your contacts or if you are wondering how you might better protect the goodwill in your business and intellectual property you may be able to protect your interests with a well-drafted restraint clause. If you would like solid legal advice and trustworthy commercial input, Anumis Legal offers expert commercial law guidance.

For your complimentary chat or to book an appointment so that we can advise you on your options to best protect your commercial interests, call Anumis Legal on 07 5455 6347 or book your free chat, now.