Restraint of trade

Monday, January 30, 2017

Protecting the goodwill and brand of the business and creating income and profit are the main objectives of all businesses. In an attempt to achieve these objectives business owners will often include Restraint of Trade (“ROT”) clauses in employment agreements, partnership agreements and in business sale agreements.

What are Restraint of Trade clauses?

ROT clauses are used by employers to attempt to prevent:

  • Current or former employees or partners from using the trade information obtained in the course of their employment for their own benefits,
  • ‘Snatching’ existing clients, or
  • Competing with the business for a period of time within a specified geographic area/territory.

The effect of a valid ROT clause is that the employee is restrained from taking certain action, which may include, but not limited to:

  • Engaging in alternative employment with another employer during the term of the employment,
  • Soliciting the company’s clients once employment has ended,
  • Disclosing confidential information post employment, and
  • Poaching/soliciting of other employees to work in competition with the employer.

ROT clauses are also used by business buyers to restrain the seller from starting up or trading in a competing business immediately after the business sale.

Courts Attitude on ROT

Courts will only enforce ROT clauses if they are deemed reasonable. However, previous cases show the courts are often  reluctant to enforce ROT clauses.

The courts have, from time to time, pointed out that any restrictions on trade can only be justified if it is reasonable in the interests of the parties concerned and reasonable in the public interests. In other words, whilst adequate protection should be afforded to a party to protect genuine business interest, such protection must not at the same time be adverse to the public.

What to look out for in a ROT clause

The mere presence of a ROT clause in any contractual document does not make it enforceable. Whether or not a clause is enforceable depends on a number of factors:

(a) Genuine & legitimate interests

For a restraint to be reasonable there must be a genuine and legitimate interest that needs protection and the restraint should be limited to protecting that interest.  The ROT clause must not be too broad by preventing the party being restrained from working at all or having any non-employment involvement (such as share holding) in another company which competes with the employer.

Further, consideration should be given as to whether there are other existing competing businesses in the area. If there are, the restraint may be deemed to restrict the person’s competition in the area rather than protecting any legitimate interest. Such restraint will have little justification in public interest.

(b) Nature of the business & clientele

It is important to have a properly drafted restraint clause which takes into account the standard practice of the relevant industry. For example, for  a business that  does not engage with a regular and recurring client base, a restraint which purports to prevent or limit an employee’s contact with previous clients of the business is unlikely to be reasonable.

However, if the person has a high level of contact with recurring clients and the business is dependent on such contact being made, it may be reasonable for a restraint to be placed to prevent soliciting of clients after the employment has ended or after business sale.

(c) Nature of the restrained party’s role and exposure to confidential information

Protecting trade secrets and confidential information is essential to ensure the continuing success of any business. In appropriate circumstances, it may be reasonable to restrain a former employee who had knowledge of confidential information in his/her employment term from disclosing the information if the disclosure of such information to competitors will be detrimental to the business.

(d) Scope & duration of the restraint

A ROT clause will only be deemed reasonable if a limit is set for the geographical area and the duration of the restraint. In general, the restraint should not cover a geographical area that is larger than necessary to protect the business interests while the period of restraint should not be for a time period that is longer than necessary to protect the business interest.

Care should be taken when incorporating ‘standard’ ROT clauses into any agreement. Properly drafted ROT clauses can be helpful in protecting genuine business interests. It is important for businesses to identify precisely what interests that the owners wish to protect, in what area and for what time and ensure the restriction of trade is limited to that. It is advisable to seek legal advice to ensure any ROT clauses you have in place are likely to be enforceable.

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