Restraint of trade clauses in business acquisitions

by Evelyn Woo, Senior Associate, Guild Lawyers

Contracts for the sale of a business often contain a restraint of trade clause, which usually seeks to restrain the vendor (and possibly key persons such as directors) from setting up a business in direct competition with and interfering in, the existing business. Problems may arise if careful consideration is not given to these clauses.

Sometimes vendors agree to a restraint that they later find to be untenable. Similarly, for purchasers, there may be uncertainty about the type and extent of the restraint that is necessary to protect the value of the goodwill they are acquiring in the business.

If the restraint clause is not drafted appropriately, problems may arise for both purchasers and vendors, which may be time-consuming and expensive to resolve. For these reasons both parties should carefully consider this clause, including how to increase the chances of a restraint of trade, or at least parts of the restraint of trade, being enforceable.

Enforceability
The law generally presumes that a restraint of trade clause is void as it is against public policy. This presumption can be rebutted and the clause enforced where the restraint is reasonable in the interest of the parties and the public. The onus of establishing whether the restraint is reasonable rests on the person seeking to rely on the restraint. Generally, for a restraint of trade to be reasonable it must go no further than is necessary to protect the legitimate interests of the party seeking to take advantage of the clause.

If a restraint of trade clause is challenged, a court will usually consider the whole transaction, including matters such as the legitimate interests which the party seeking to uphold the restraint is entitled to protect, the breadth of conduct restrained and whether the restraint extends beyond the protection of such interests.

Maximise your chances
To maximise the chances of the restraint of trade being enforceable, purchasers should consider what is likely to be considered as his or her legitimate interests then ensure that the restraint goes no further than is necessary to protect those interests.

There are four variables that need to be considered in relation to a restraint of trade:
1. persons who are to be the subject of the restraint obligations
2. geographical extent
3. time period
4. prohibited conduct which is to be the subject of the restraint.

Generally, restraints that are unlimited in their geographical extent or time, or which prohibit a vendor from obtaining any income, are likely to be considered too broad, and therefore unenforceable.

Careful drafting can also increase the chances of a restraint of trade, or at least parts of the restraint of trade, being enforceable. Courts in certain circumstances are able to remove from the contract those parts of the restraint of trade that they consider to be unreasonable. The courts will do so only if an individual word or words can be deleted from the restraint of trade clause and the clause will still have grammatical and substantive meaning to create a reasonable restraint. The courts will generally not substitute their drafting for that of the parties. Although in New South Wales, in some circumstances the court may have the flexibility to modify unreasonable restraints to make them enforceable.

The use of restraint of trade, intellectual property and confidentiality clauses in employment contracts can also help protect the value of a business. Look out for further information on restraint of trade in employment contracts in the near future.

For further information, contact Guild Lawyers’ Evelyn Woo at This email address is being protected from spam bots, you need Javascript enabled to view it or 1800 617 624.