15 Oct 2019

HHG Legal Group’s Commercial Law and Dispute Resolutions lawyers Murray Thornhill, Blair Campbell and Nikolina Milošević discuss restraint of trade. 

restraint of trade in Article image

Restraint of trade clauses are common clauses included in a wide array of commercial agreements (predominantly in sale of business and employment agreements). Their purpose is to restrict or prohibit a party (restrained party) from engaging in certain acts relating to their trade, profession or business, in a certain location for a specified period of time, for the benefit and protection of the other party to that contract (restraining party).

Restraints of trade in sale of business contracts are more likely to be effective, and for a longer period of time, than restraints contained in employment contracts. Additionally, it is common practice to draft the clause as a cascading clause, where the restrained period of time, acts and geographical location gradually decrease. For example, the clause might state that the restraint is for a period of three years, and if that is considered unreasonable then it is for a period of two years, and then one year. If drafted correctly, and the restraining party has the time and financial resources to fund enforcement, they can be a good way to protect business goodwill.

When dealing with a restraint of trade issue a Court will begin its assessment from the perspective that a restraint of trade clause will be void, this is because of the public policy of allowing people to utilise their skill to earn a living as they choose. This perspective can be changed if the restraining party satisfies the Court of the need and reasonableness of the restraint.

The responsibility is on the restraining party to show to the Court why the restraint should not be void, and that enforcement is reasonable and necessary in the circumstances. The process involved in enforcing a restraint is often by seeking an urgent injunction to prevent the restrained party from continuing to breach the clause, and then proceeding to trial for damages arising out of a breach of the restraint.

The effectiveness of a restraint of trade clause will heavily depend on the circumstances of the case, the way the clause is drafted, whether the restraint is reasonable, and, most importantly, the interest being protected. An important consideration for parties to such action includes the resources available to the restraining party to enforce the restraint.

The matters assessed by the Court in deciding whether a restraint of trade is enforceable include:

  1. Whether the restraint is reasonable – the restraining party must show that the restraint of trade does not go beyond that which is reasonably necessary to protect the restraining party;
  2. Whether the restraint is harmful to the public interest;
  3. How much of the purchase price of the business was attributed to goodwill of the business – the more consideration paid towards goodwill, the likelier it is that the restraint is necessary to protect the business;
  4. The reasonableness of the restraint in real life, and not just in its contractual form;
  5. The restrained person’s trade and potential to earn a living;
  6. The geographical limitations imposed;
  7. The period of time for which the restraint is in effect;
  8. The commercial context – this includes the nature of the contract, industry, and the standard restraint practices in the industry; and
  9. The types of acts which the party is restrained from engaging in.[1]

As with all injunctions, the Court also takes into consideration whether there is a prima facie case (i.e. a breach of the restraint) and whether the balance of convenience favours the granting of the injunction.[2] Again, the responsibility falls on the restraining party to show that the balance of convenience favours the grant of the injunction.

The principal factors the Court takes into consideration are:

  1. Whether damages are an adequate remedy for the damage; and
  2. Whether the damage the restraining party would suffer outweighs the damage which the restrained party would suffer if the injunction is allowed.

The restraining party must also be prepared to give an undertaking as to damages if the injunction is granted. This ensures that if the restrained party suffers damage as a result of the injunction, and the outcome of the proceedings following the grant of the injunction establishes that the restrained party did not breach the clause, damages will be payable by the restraining party to compensate the restrained party.

If you are considering selling a business, leaving a franchise, or signing an employment contract with restraint of trade clauses, or may potentially be in a situation where an employee or seller of the business you have bought is breaching a restraint, contact our experienced legal team to see how we can assist you with protecting your rights.

 

[1] Devil Dog Pty Ltd -v- Cook [2017] WASC 27, 12.

[2] Ibid, 11.

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