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RESTRAINT OF TRADE

WHAT IS RESTRAINT OF TRADE?  

A restraint of trade is any contractual term which seeks to restrict the freedom of a party to engage in business.  The concept is best explained by way of example. 

Common types of restraints of trade are the following:  

Employment agreements often contain restraints, both within and outside of the employment relationship. That is, the employee might be restrained from engaging in any other paid work while his employment continues, or he might be restricted in the type of other work he can do. There might also be a restraint on what he can do after his employment ends. Usually this will prevent him from competing with his former employer, such as by working for a competitor or setting up his own competing business.  

Sale of business agreements often restrain the vendor of the business from competing with the business being sold.  

Partnership or joint venture agreements between businesses, shareholder agreements and other agreements where people or companies are required to co-operate with each other for a common goal often contain restraints on the parties from competing with the venture.  

Franchise agreements normally contain restraint of trade clauses which prevent the franchisee from continuing with a competing business after the franchise agreement has come to an end.

As can be seen from the examples, the underlying purpose of restraints of trade is to protect a party's business from competition, that potential competition coming from a person who is well placed to compete effectively. This is because the person may have acquired knowledge, skill, contacts, goodwill and reputation which he will be able to exploit on his own account or for the benefit of another competitor.  

The law says that all restraints of trade are unenforceable and void, unless they are reasonable. So, unlike normal contractual terms, which are valid unless there is some reason for them not to be, restraint of trade provisions are deemed to be invalid unless it is proved that they are reasonable. 

The party seeking to impose the restraint has the onus of proving reasonableness. For example, say a professional football player's contract says that when his contract ends he cannot play for any other team in the competition. The football club will only be able to enforce this restraint if it can prove that it is reasonable in all the circumstances. A court will consider the effect of the restraint on the player, as well as the necessity for the club to have the restraint in order to protect its position.  The restraint in the above example would be held invalid as it is not reasonable. The club has no valid reason for restraining a former player from playing for another team. If the restraint was upheld, the player would effectively be prevented from earning a living from his usual occupation.  

The intentions of the parties and their relative bargaining power will not be relevant to the question of whether a restraint is held to be reasonable. It either is or it is not, regardless of what the parties thought at the time they agreed to it.  

To be reasonable, a restraint must be limited as to time, location and extent.  An open ended restraint will generally be struck down. What is a reasonable time depends on the circumstances. For example, in a sale of business context, two years might be reasonable, but five years would almost certainly not.  The same applies to location. 

Restraints are often made subject to a geographical limitation, either by specific reference (eg within a suburb or a state) or by radius (eg 5 kilometres from a specific location). Again, what is reasonable depends on what is reasonably necessary. It would certainly be reasonable for a vendor of a successful business to be restrained from opening up a competing business within the same suburb, but probably not the same city or state.  

The restraint also has to be specific as to its extent. It must allow the party being restrained to continue to earn a living using their skills and know-how. It cannot prevent them from engaging in unrelated work or business.  You might have seen a restraint of trade clause in a contract which sets out alternatives. For example, it might say that a party cannot compete within a radius of 2, 5 or 10 kilometres, for 6 months, 1 year or 2 years. The reason clauses are drafted this way is because a court cannot "read down" a restraint clause. That means, if the restraint is unreasonable it will be struck out entirely, not replaced with something more reasonable. If however alternatives are stated, the court can strike out the unreasonable alternatives but leave the reasonable ones in place. In the above example, the court might decide that 5 and 10 kilometres and 2 years are unreasonable, but uphold the restraint for 2 kilometres and 1 year.  

If you wish to include a restraint in a contract, you must take care to make it only sufficiently wide to protect your legitimate business interests, otherwise it will certainly be held invalid.  This is an area of considerable legal complexity. You should seek expert legal advice if you have any doubts.   

HOW TO ENFORCE A RESTRAINT OF TRADE CLAUSE   

If you have a contract with another party which contains a restraint of trade clause, and the other party breaches the restraint, you should take the following steps:

  1. Satisfy yourself that the restraint is actually being breached. Do not rely on hearsay from others.  
  2. Try to obtain evidence of the breach. This will be very important if you need to take court action. It is best to obtain this evidence via independent parties, for example your solicitor or a private investigator. Evidence can be obtained by "devious means", provided they are not illegal. For example, make a telephone call to see how the calls are being answered, send someone in to a shop to ascertain what is being sold and to buy samples (remembering to keep the receipt!), even get photographic or video evidence.  
  3. Write a letter of demand to the other party. The purpose of the letter is to put the party on notice that they are in breach of the restraint and to give them an opportunity to rectify the breach by ceasing the offending activity. You can put a very short deadline on such a demand, because of the urgency of the matter. In some cases, a few hours will suffice.   

If the breach continues, you have two alternatives:

  • You can terminate the contract, which may or may not suit your purposes. 
  • You can also commence court proceedings against the party in breach. 

The three available remedies for breach of a restraint clause are: 

  • an injunction, which is a court order preventing the party from continuing the activity which is in breach of the restraint; 
  • damages, to compensate any loss you suffer as a result of the breach; and 
  • an account of any profits made by the party in breach.  

If litigation becomes necessary, it is absolutely essential that you move quickly. You should instruct solicitors as a matter of urgency at this point. Any substantial delay will make it less likely that you will be able to obtain an injunction, which is the most effective means of protecting your goodwill.    

WHAT TO DO IF YOU ARE BOUND BY A RESTRAINT OF TRADE CLAUSE   

If you are a party to a contract which contains a restraint of trade clause against you, the first thing you need to do is be fully aware of the terms of the restraint and understand exactly what it prevents you from doing.  If a situation arises where you consider you need to undertake some activity which may be in breach of the restraint of trade clause, you should give careful consideration to the consequences. 

If you breach the restraint, you should assume that the other party to the contract will take all available steps to stop you. This will include court action. If that action succeeds, you may be liable for damages and to pay the legal costs of the litigation, of both you and the other party. This type of litigation can be very expensive.  

You should obtain legal advice regarding the situation. A solicitor will be able to advise you as to whether your proposed activity will in fact breach the restraint. He or she will also advise you whether the restraint of trade clause is enforceable. If the restraint is unreasonable (usually because it is too broad), it will be liable to be held void by a court.  If your legal advice is that the restraint is unreasonable, then you might consider running the risk of breaching it. This will be a commercial decision, and you will have to weigh up the costs and benefits yourself.  

It is generally better to warn the other party of your proposed activity before you embark upon it. This does give the other party an opportunity to prevent you by going to court immediately, but it also means that if they do nothing it is much harder for them to complain later and will make it particularly difficult for them to obtain an injunction.  

Alternatively, you can bring your own court proceedings to seek to have the restraint clause declared void as unreasonable. Unfortunately, neither option is cheap or without risk, but that is because you agreed in the first place to enter into a contract with a restraint clause in it.    

FURTHER INFORMATION

For more information or formal advice, contact Marks and Sands Lawyers who are experienced in this area of law. They are located at Level 9, 30 The Esplanade Perth WA 6000 or call them on (08) 9488 1300.

Marks & Sands Lawyers is one of the largest independent law firms in Western Australia and has been providing legal services to the community for over 25 years. Our legal services are certified by Standards Australia Quality. We provide a broad range of legal services for government agencies, corporations, small businesses and private individuals. We offer a 24 hour, 7 day service and have branch offices in Wagin and Merredin - our country connections remain strong. Call us to discuss your situation or to arrange an appointment.

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