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When entering a sale of business agreement, it makes a lot of commercial sense for the buyer to seek to limit the seller and key employees’ from starting or working for a competing business. Likewise, a buyer would want to restrict the seller from soliciting clients, suppliers or key workers of the business. The client and supplier relationships and the workers are some of the most valuable assets that the buyer is purchasing. Further, if the seller or a key employee starts a competing business, they benefit from the know-how and prior experience of having previously operated the business. On that basis, it is not unusual for the sale of business agreement to include restraint of trade clauses. This article explains what restraints are from the perspective of a buyer and when they are enforceable.

To Whom Do Restraints Apply?

In a sale of business agreement, restraint of trade clauses typically apply to the seller and to key employees who have not transferred as part of the sale. A key employee can include:

  • directors;
  • C-suite employees; 
  • key service providers, for example, the head physiotherapist for a physiotherapy business; or 
  • key sales personnel.

Likewise, as a buyer, negotiating to include restraint clauses in the sale of business agreement can be very beneficial to you.

What Are Restraints?

There are generally two types of restraints: non-solicitation and non-competition.

Non-solicitation restraints

Prevent the seller and key employees from soliciting, poaching, approaching or accepting an approach from key stakeholders and from working for or acting in any capacity for a key stakeholder. The non-solicitation restraints can prevent this conduct in respect of clients, suppliers, employees, contractors, consultants, agents or investors.

Non-competition restraints

Prevent the seller and key employees from being engaged as or acting as an employee, contractor, consultant, director or agent of a competing business or from starting a competing business.

The parties may agree to define what amounts to a competing business. Broadly, it can be a business that provides services that are the same or similar to the sellers. You can choose to define a competing business by reference to a specific industry. For example, “a business that provides services in the physiotherapy industry.” Alternatively, your definition can be narrow by providing a specific list of competing businesses that are of concern. Without a clear definition, parties may otherwise rely on the ordinary meaning of the term “competing business.”

When defining restraints in your sale of business agreement, you can do so by reference to a restraint area and a restraint period. Accordingly, you are seeking to prohibit the seller from conducting business within a specified restraint area and a period from the settlement date.

Indeed, you can define a restraint area broadly (e.g. Australia or New South Wales) or by reference to the business’ location (e.g. within a 6-kilometre radius of the location).

Legal Enforceability

Even if the sale of business agreement includes restraint clauses, there will always be a question of their enforceability. As a matter of public policy, courts are generally reluctant to enforce restraints. This is because such restraints can limit the ability of key employees or the seller (if the seller is an individual) from earning a living and can limit competition.

However, a court is willing to enforce a restraint where it is reasonable to protect the buyer’s legitimate business interests. Legitimate business interests can include confidential information, intellectual property and stakeholder relationships.

What is reasonable will depend on the unique facts at the time the parties agreed upon and entered into the restraint. In the sale of business context, a court will examine several factors, including the:

  • nature of the business;
  • location of the business;
  • goodwill of the business;
  • consideration paid for the business, essentially, the sale price;
  • negotiations between the parties before entering into the agreement; and
  • terms of any specific special conditions that formed part of the business sale agreement.

Reasonableness

What is reasonable may also depend on the way that you draft the restraint clause, by reference to the restraint period or restraint location. For example, it may be reasonable to restrict the seller or key employees from starting a competing business within a 10-kilometre radius of the business’ location. However, it may not be reasonable to limit this conduct within the whole of Australia. Similarly, it may be reasonable to restrict the seller from soliciting clients of the business for a period of 12 months but not for 4 years.

Generally, as a buyer, you will provide valuable consideration and pay for the business’ ongoing goodwill. This is typically the case when a business is sold as a going concern. Accordingly, courts generally express a willingness to uphold restraints in these circumstances. However, this will be subject to the way they are drafted and the context of the agreement. 

Importantly, it is crucial that all clauses in your business sale agreements are well-drafted and customised to the individual facts of your relevant business and transaction.

Practical Considerations 

Unfortunately, a seller or key employee may breach the restraint of trade clause. If you become aware of a breach, you have some practical options available, including (without limitation):

  • sending the seller or key employee a cease and desist letter requesting the person stop the breaching conduct. You may also request an undertaking from the seller or key employee. An undertaking is a highly enforceable promise from the seller or key employee that they will cease the conduct;
  • applying and seeking an injunction. An injunction is a stop order from the court to ensure that a party creases their breaching conduct; or
  • commencing legal proceedings for breach of contract to seek compensation.

As a buyer, you want to consider whether the restraint is likely to be legally enforceable or not before determining the most appropriate action to take. If the restraint is unlikely to be enforceable, you will have uncertainty about the outcome of any legal proceedings. Hence, it is best to refrain from commencing proceedings. On the other hand, if you have certainty, you will be more likely to take immediate action. Likewise, you should also consider whether the seller or key employee will be liable for your legal costs.

Even if you have certainty, engaging a lawyer to prepare a cease and desist letter and commencing proceedings is costly and time-consuming.

Indeed, it can also be useful to consider whether you are motivated to take any legal action. Your motivation may be influenced by the commercial impact of the seller’s breaching conduct. For example, suppose the seller or a key employee sets up a new business but you have already secured the existing client relationships. In this scenario, you may not be overly motivated to take action.

Key Takeaways

If you are entering a sale of business agreement, you should consider whether any restraints limit the seller or key employee’s ability to solicit stakeholders or to act in competition with the business. As a buyer, you should ensure they are well drafted and consider what would be reasonable in the circumstances. Doing so will increase the likelihood of their enforceability. 

For assistance with preparing or negotiating restraint clauses, or to consider their enforceability, contact LegalVision’s sale of business lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

How does a court assess the reasonableness of a restraint of trade clause?

Generally, 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. Firstly, it must be reasonable between the parties to the agreement. Secondly, it must not be harmful to the public interest.

How do I determine when to enforce my restraint clause?

As a buyer, you want to consider whether a court will likely find your restraint to be legally enforceable. If not, you may decide against taking legal action. Also, consider how motivated you are to enforcing your restraint.

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