Restrictive Covenants: Do Not Rest On Your Laurels
It is common for commercial contracts to include clauses preventing certain actions. This post will look at what these clauses are and why they are used.
Restrictive Covenants (or restraint of trade clauses as they can be known) are clauses that seek to limit a business or individuals freedom to practise their trade for a limited amount of time. These can be found in numerous types of contracts, all the way from employment contracts to share sale agreements to shareholder agreements. They are very common when selling or buying a business or entering into agreements with business partners. Generally, for a Restrictive Covenant to be enforceable, it has to fulfill certain criteria. These are that they;
- Are designed to protect a legitimate business interest.
- Are no wider than reasonably necessary to protect that interest.
- Are not contrary to the public interest.
These criteria have been scrutinised and defined over a significant period of time through case law. As an example, if you were purchasing a business then you would want to ensure that the seller could not open up a store down the road from the business you are purchasing after you have bought the business (as there would be little commercial value in buying the business in the first place if this could happen). This is an accepted legitimate business interest to protect. However you could not place a Restrictive Covenant upon that seller for an unlimited amount of time that they could not ‘set up shop’ again, as this would be impacting their ability to practise their trade and impact competition in general.
These covenants can also be used in a range of other scenarios, such to stop a client from poaching your staff members (which can happen a lot in industries such as IT or marketing). They can also be used to stop your supplier poaching your customer or your customers from dealing with your suppliers (in a purely business to business context).
If a Restrictive Covenant is considered to be too wide or not protect a legitimate business interest then the courts could seek to strike out that particular clause from a commercial contract, which in essence would mean it’s not worth the paper it’s written on. Careful consideration should be given when either drafting these clauses or entering into an agreement which contains such clauses to ensure you know exactly what you’re getting into and if it is fit for purpose.
