How Does a Restraint of Trade Clause Work in England?

As a business, you must protect your commercial interests from businesses or shareholders who may seek to take advantage of your intellectual property. Thus, a restraint of trade clause may provide the protection you require. While our law treats restraint of trade clauses within commercial contracts similarly to those within an employment context, there are some key differences. This article will focus on the restraint of trade clauses within commercial contracts with shareholders or other businesses rather than employees. This should help your business use such clauses effectively within commercial agreements.

What is a Restraint of Trade Clause?

Generally speaking, they include contract clauses that restrict someone from doing something for a certain amount of time. As with everything, this sounds very simple, but in practice, your business will face several legal hurdles enforcing them.

How Could These Clauses Be Helpful to My Business?

One practical example is a former shareholder (who is not an employee) wishing to sell shares. You may manage to have that shareholder agree to a contract to sell those shares, including a restraint of trade clause. This is because that shareholder may compete with your business by using their knowledge of your clients, the business sector and how your company operates. Alternatively, they could invest or seek employment with one of your rivals and use that information against you.

Obstacles to Enforcing a Restraint of Trade Clause

Our courts value several principles very highly in commercial law. In the case of the hypothetical shareholder, a court would only enforce a restraint of trade clause if it agrees that:

• doing so would protect a legitimate business interest;
• it is not wider than reasonably necessary to protect that interest; and
• it is not contrary to the public interest.

Your clause is only enforceable if a judge agrees it satisfies the above requirements.

Example

Suppose your business is one of three major disposable coffee cup providers in the UK. One of your shareholders, who has been a non-employee shareholder for ten years, wishes to sell their 33% stake in the company. Your company has recently designed and tested a revolutionary disposable coffee cup. It uses 25% less raw materials to produce, is fully recyclable and costs 50% less to make. However, the patent is still pending. Production of the cup would give your business a significant profit advantage over the other two rival companies.

You are worried that the shareholder may take their knowledge and share the secret design with your rivals. Even if they do not know the specifications of the new cup, they can inform your competitors of your plans, so they can try to design their own versions.

You ask the shareholder to sell the shares to you directly but within a written agreement setting out a strong restraint of trade clause. The clause stops the shareholder from buying shares or joining a rival company in the same sector for two years. The two-year period is perfect for your company as you believe the product will be finalised and patented by then.

The shareholder signs the written agreement but later argues that it is an unreasonable restraint of trade (and therefore void). Let us explore what a court may consider below.

1. Legitimate Business Interest

Your company is likely to have a legitimate business interest here. It has designed a revolutionary product that can transform the market and give your company a massive advantage over competitors. A court will likely hold that your business is legitimately seeking to protect its trade secrets and confidential information.

2. Wider Than Reasonably Necessary Test

The two-year limit on involvement with a rival company is likely fair because that is a reasonable time to design, produce and patent the new cup design fully. The fact that the clause only prevents investment and involvement in companies in the same sector ensures that it complies with this requirement.

However, if the clause prohibited investment in any UK company, this may be wider than reasonably necessary. Similarly, the clause only applies to a specific geographical area (the United Kingdom). If it tried to stop investment or involvement in any company globally, this may be too wide.

3. Contrary to Public Interest Test

If your business passes the first two tests, it is relatively uncommon to fail this third test. Instead, this test tends to catch contracts between employers and employees. This is because courts do not believe public opinion is relevant to commercial contracts. In this way, it is only when a court believes the restraint of trade clause would breach EU (or UK) competition law that this test may become relevant.

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Key Takeaways

Our courts tend to permit restraint of trade clauses much more readily within commercial contracts than employment law contracts. This is because our law respects the ability of commercial parties to agree on deals with a more balanced bargaining position. When seeking to agree on a restraint of trade clause with a commercial party, it is helpful to have a lawyer help draft the clause to maximise its chance of enforcement.

If you need help with restraint of trade clauses, our experienced contract lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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