Restrictive covenants

| 4 min read

Some types of contract, notably those for services and of employment often contain clauses that seek to restrict or to prevent future competition. That might take the form of soliciting customers, setting up a new business in direct competition, or poaching employees. These types of clauses are known as restrictive covenants.

Non-competition

Non-compete clauses prevent one of the parties to the contract from competing with the other. As well as providing recourse if the party does enter into competition, they provide a reminder as to be careful of next steps, whether that is starting a new business or working for a different business.

Sometimes, the terms agreed for non-competition are so extensive that they are placed in their own stand-alone agreement.

Uses of non-compete clauses

Consultancy contracts often include non-compete terms as well as those relating to confidentiality. The aim of these terms is often to strengthen the effect of the non-disclosure terms - it is harder to disclose timely or sensitive information to a competitor if there is a restriction on working for that competitor.

A buyer of a business might include in the business sale agreement that the seller does not set up a new business in the same industry or with a similar business model within a certain period of time. Such a term is a relatively common in these types of agreements because the buyer is in a weakened position if the seller did start up in competition.

In a distribution agreement, the distributor may be given exclusive distribution rights. In return, the manufacturer might require that the distributor does not act for the manufacturer's competition, either during the term of the agreement or for a period of time afterwards.

Many employment contracts for senior employees include post-employment restrictions not to work for a competitor. These type of non-competition clauses are usually the most contentious - an employee's value to another employer is usually based on his or her previous experience directly in an industry. However, businesses have legitimate interests to protect confidential information and trade secrets.

Are non-compete clauses enforceable?

Clauses tend to be enforceable if they are reasonable, and provided that they don't break any anti-competition law. Reasonableness is subjective and depends on each case. As a rule of thumb, reasonable is what is necessary to protect legitimate commercial interests, both for the parties themselves and for the greater public interest.

The duration of the non-competition clause is important. There should be a time limit, which should be no longer than necessary. Open ended time limits are very likely to be unreasonable.

It is assumed that someone can only compete within the same, or a nearby geographical location, and in the same or a similar business industry. A clause that seeks to restrict someone or a business from working in too wide a territory or industry is likely to be unreasonable.

There also exists anti-competition law. This aims to prevent businesses from acting outside of the interests of certain stakeholders, particularly where the business holds far more power than other stakeholders, for example by price-fixing, market sharing or agreeing to limit activity.

Non-solicitation

Non-solicitation covenants prevent one of the parties from approaching the customers of the other in an attempt to win work from them.

Sometimes the terms might forbid buying from suppliers. However, non-solicitation of suppliers is less common and usually is only included in the contract if the supplier was helped to develop a product or service by the customer.

Non-dealing

Non-dealing is similar to non-solicitation. In addition to preventing the party from approaching customers, it prevents any transaction in any circumstances. This means that even if the customer approaches the party, the party cannot deal with the customer.

Non-poaching

Poaching means inducing someone to leave a current situation and join the person soliciting them. It is usually employees who poached by a former manager into a competitor business, but sometimes the staff of a closely integrated client or supplier might be approached.

Inclusion of restrictive covenants as a deterrent

Often, a legal document draftsman will intentionally include terms that are likely to be unenforceable, expecting that they will never be challenged.

Many people will sign a contract that contains restrictive terms and assume that because they have agreed to them, they will always be enforceable.

Restraint of trade

Restraint of trade happens when restrictive covenants prevent sopmeone in business from carrying out their trade, particularly if the terms exceed what would be reasonably necessary to protect the legitimate commercial interests of the party restricting the other.

As with other judgements of reasonableness, courts look at restraint of trade on a case-by-case basis. If the term is unreasonable or unfair it is judged to be void and unenforceable.

Please note that the information provided on this page:

  • Does not provide a complete or authoritative statement of the law;
  • Does not constitute legal advice by Net Lawman;
  • Does not create a contractual relationship;
  • Does not form part of any other advice, whether paid or free.
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