Restraint of trade provisions in Business Purchase Agreements in Ireland and Northern Ireland – they are (in principle) void and unenforceable unless they are enforceable

What are restraint of trade provisions?

Restraint of trade provisions are typically included in a broad spectrum of agreements between businesses and individuals (including employment and commercial contracts) and operate to limit any competition with the relevant business. 

The focus of this article, however, is on their use in business purchase agreements (for both assets and shares) and the implications of their use for a buyer.  The restraint of trade provisions in business purchase agreements predominantly operate by restricting the freedom of the seller from pursuing their trade in competition with the target business after the purchase of the business.

Typical restraint of trade provisions in business purchase agreements include:

·         non-competes, which expressly limit the ability to compete with the applicable business;

·         non-solicitation of customer provisions, which limit the ability to contact and/or take the customers of another party; and

·         non-solicitation of employees, which limit the ability to engage or employ the employees of another party.

Enforceability:  the starting position

As the use of restraint of trade provisions is so wide and given that parties are typically allowed the freedom to contract, it may be a surprise to some that such provisions are generally regarded as void and unenforceable under the doctrine of the restraint of trade. 

This is unless they are designed to (i) protect a legitimate business interest of the party imposing the restraint, (ii) be no wider than reasonably necessary to protect that interest and (iii) not be contrary to any public interest.

It is therefore important to establish (i) what constitutes a legitimate business interest, (ii) what is considered ‘reasonably necessary’ and (iii) what the applicable public interests are.

Legitimate business interests

In business sale agreements, the goodwill of the target is usually the interest being protected and the buyer has a legitimate business interest to prevent the seller from starting another business which competes with the target.  The existence of the restraint of trade is baked into the purchase price, and without it, the ‘whole transaction would be valueless’ (per Lord Shaw, Herbet Morris Ltd v Saxelby [1916] 1 AC 688).

The legitimate interest does not have to be expressly referred to in the business purchase agreement and, in Harcus Sinclair LLP v Your Lawyers Ltd [2011] UKSC 32, the Supreme Court held that consideration of the parties’ non-contractual intentions may be taken into consideration.

Reasonableness of the restraint

“Reasonableness” means that no party may acquire any more protection than is necessary to safeguard the relevant legitimate interest, and it is accepted that reasonableness should be considered in respect of (i) the restraint’s duration, (ii) geographical area and (iii) the scope and nature of the activities covered.  Of course, as is typical for the courts, other factors (such as inequality of bargaining power) will be considered, but those three areas are the principal areas of concern.

Duration of restraint  

From an analysis of case law, and contrary to a buyer’s instinct to extend restraints for as long as possible, it is evident that the longer the term is for the restraint, the greater the likelihood that the courts will find it to be unreasonable. 

For example, consider Ivy Technology Ltd v Martin [2022] EWHC 1218, which involved (among other claims) an alleged breach of a non-compete clause in a sale and purchase agreement for the shares of a betting business by the seller (who had set up a competing business which poached the target business’s employees and customers). The courts held that a five-year restriction on competing with the target business and contacting or soliciting its employees and customers was invalid as it was too long (and therefore not ‘reasonably necessary’).

In contrast, in Goldsoll v Goodman [1915] 1 Ch 292, which involved a breach of a two-year restrictive covenant in a share purchase agreement for the purchase by one imitation jewellery dealer of another’s business, the two-year term was deemed valid by the court (even though the overall covenant was deemed invalid due to being too wide in geographical scope).  

Lawyers generally will advise that buyers ought to err on the side of caution by suggesting two or possibly three years’ duration.

Geographical area for the restraint

The reasonableness of restraining trade within the limits of a certain geographical area has, given the developments in technology, become slightly more complex.  Where previously a business would simply operate in one local area, a lot of businesses now have extended scope through, for example, the increased use of e-commerce. This was noted in Merlin Financial Consultants v Cooper [2014] EWHC 1196 where it was held that the financial services market was a single geographical market (and markedly so because of the ability to communicate electronically).

However, in a sale of business context, the overall protection of the goodwill of the target business is again considered priority and, in Office Angels Ltd v Rainer-Thomas [1991] 3 WLUK 166, it has been accepted that the seller’s non-compete provision should be limited to the territory in which competition would likely to injure the buyer’s enjoyment of the goodwill it has acquired.  Essentially, the goodwill is what is purchased, and any competition lowers its worth.

This means that a restriction on the seller of a business that operates locally but restrains them from running the same type of business anywhere else is likely to be unreasonable. Of course, this is subject to some exceptions, including the type and size of the business in question (for example, if it is the only business of its type in a county or country, a wider restriction could be considered reasonable or, alternatively, if it is a common type of business such as a coffee shop, even a local restriction could be considered unreasonable as there is scope to have more than one coffee shop in one area).

Scope of activities

This is accepted as simply not restraining activities beyond those which need to be restrained to legitimately protect the applicable interest.  It is generally accepted that this may be difficult to determine, so the courts are prepared to be slightly flexible when determining whether an activity is within the scope and nature of activities to be restrained. 

Reasonableness and the public interest

The courts tend to uphold any restraint that is reasonable between the parties, but restraints are also considered in the context of the public interest. Interestingly, while the focus of the ‘public interest’ changes over time (for example, there is now more of a focus on the environment as a public interest than there was 30 years ago), over 100 years ago Lord MacNaughton (in Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1891-94] ALL ER Rep 1) noted the importance for the public of an individual’s ability to trade freely (a sentiment that is still applicable today). He stated that:

“The public have an interest in every person’s carrying on his trade freely: so has the individual. All interference with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy, and, therefore, void”

Therefore, the circumstances must be completely clear as being in the public interest before the courts will consider them to be unreasonable in the restraint of individual trade and the number of cases which have ruled restraint as unreasonable in the public interest (especially in the context of the sale of businesses) is limited.

How to ensure your proposed restraints are valid

To avoid the risk of a restraint of trade provision being held void and unenforceable, a buyer (and its advisors) should keep some of these tips in mind:

• consider the possibility of the bargaining relationship being held to be unequal (for example, when a buyer is more experienced in business and/or business sales than the seller or where there is the possibility that the price for the shares is determined as for less than adequate consideration).  Such a buyer should ensure that the seller takes its own independent legal advice, but note that even this may not negate the risk that a court will consider that the bargaining relationship was unequal;

• clearly identify what your ‘legitimate interests’ are  so that the provisions can be drafted narrowly to ensure restrictions are reasonable.  Defining the interests in the agreement may help;

  • always pay attention to the duration, geographic scope and scope of the restricted activities; and

  • consider including a provision to allow the seller to partake in the restricted activity with consent.

This advice is written by Gemma Boyle, Corporate & Commercial Solicitor.

If you would like to contact Gemma, please click here.