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Most sale of business contracts will include a restraint of trade clause. This clause designs to protect the purchaser by preventing the vendor from opening up a competing business nearby. As a purchaser or a vendor, it is important to know what kind of restraint is suitable for the type of business is being sold and will depend on various factors. This article examines:

  • how you can draft a restraint of trade clause;
  • the law regarding these provisions; and
  • the potential consequences for breaching a restraint of trade clause. 

Drafting a Restraint of Trade Clause

Standard contracts in New South Wales (NSW), Queensland (QLD) and Victoria (VIC) include a general restraint of trade clause that will apply to a range of circumstances. The restraint clause prevents the vendor, for a specified period or geographic area, working for another business similar to the one they are selling. The phrasing of the clause will differ depending on which state or territory you live in.

For example, in NSW, the standard form contract prevents the vendor from involving themself in the same or similar business in a range of positions such as manager, agent, director or shareholder. 

However, in VIC, for businesses that are the same or substantially similar to what the vendor is selling, the vendor cannot:

  • promote it;
  • carry it on;
  • assist with its running;
  • participate in; or
  • be directly concerned with it.

Cascading Clauses

When drafting a restraint of trade clause, a cascading clause usually protects the purchaser to the greatest extent possible. A cascading clause is one that progressively decreases (e.g. three years, two years, one year). If the parties do not provide different cascading options for restraint periods and distances, a court may rule that the clause has no effect because it’s too broad. Essentially, it acts as a fallback position should the vendor challenge the initial restraint as being unreasonable.

A cascading clause might look something like this:

  1. In consideration of and for the mutual benefit of all parties entering into this contract, the vendor must not, during the Restraint Period in the Restraint Area:
    1. promote, participate in the operation of a café, undertake or enter into (whether on their own account or in a partnership or by a joint venture), the operation of a café; or
    2. be concerned or interested, directly or indirectly in any capacity including as principal, agent, manager, associate, partner, trustee shareholder, unitholder, director, employee, beneficiary, independent contractor, consultant, adviser or financier in, any café.
  2. Restraint Area means each of the following areas separately:
    1. ten kilometres from the premises, or if this restraint area is not held to be reasonable;
    2. 5 kilometres from the premises, or if this restraint area is not held to be reasonable;
    3. three kilometres from the premises.
  3. Restraint Period means each of the following periods separately:
    1. three years from the date of completion, or if this restraint period is not held to be reasonable;
    2. two years from the date of completion, or if this restraint period is not held to be reasonable;
    3. one year from the date of completion. 

Courts interpret restraint of trade clauses depending on the facts of each case and prior determinations for similar businesses at the time.

Assessing a Restraint of Trade Clause

The courts presume a restraint of trade to be unenforceable and void unless a party can justify that it is reasonable.

For a restraint to be reasonable, it must satisfy two requirements:

  • it must be reasonable between the parties to the agreement; and
  • it must not be harmful to the public interest.

Reasonableness

A restraint will be reasonable between the parties if it gives the purchaser no more protection than what is reasonable.

The first step in assessing reasonableness is to identify a legitimate protectable interest of the purchaser. A protectable interest is a property right or interest but can also include commercial interests such as interest in

  • confidential information;
  • trade secrets; or
  • economies of scale.

A number of interests will be relevant when the court determines whether the restraint is reasonable. These interests include the:

  • activities and conduct caught by the restraint;
  • relative bargaining power of the parties;
  • duration of the restraint;
  • geographical scope of the restraint;
  • benefits the vendor receives; and
  • commercial context (including standard practice in the industry).

However, the courts also consider the facts of each matter.

For example, courts have held the following restraints to be reasonable:

  • a two-year restraint across Australia was reasonable as the purchaser’s accounting practice operated Australia wide; and 
  • the court held a five-year restraint which stopped a partner who exited a partnership from competing with the business to be reasonable. This is because the partner had contacted previous customers through his wife’s company. 

Consequences for Breaching a Restraint of Trade

If the vendor has violated the restraint of trade, the court may order an injunction (i.e. an order that stops a party from doing a particular thing) and/or damages. The court will calculate damages according to the lost income or profit the purchaser suffered as a result of the vendor’s actions in breach of the restraint.

The facts of the case will determine whether or not the purchaser suffered any actual loss, and if so, what amount the court should award.

Key Takeaways

Assessing whether a restraint of trade clause in a sale of business agreement is reasonable is driven by each case’s unique facts. It’s essential for any purchaser or vendor in a transaction to protect their interests while agreeing to some degree of compromise. If you have any questions about restraint of trade clauses, LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

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