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When purchasing a business, it helps include a restraint of trade clause in the sale of business contracts. This clause aims to protect you (as the purchaser) by preventing the vendor from opening up a competing business nearby after the sale is complete. As a purchaser, it is essential to know what kind of restraint is suitable. This article unpacks:

  • drafting a restraint of trade clause;
  • the law regarding these provisions; and
  • the consequences for breaching a restraint of trade clause. 

Drafting a Restraint of Trade Clause

Restraint clauses prevent the vendor from operating a competing business within a specified period and within a specified geographic area. It is vital to consider what is meant by ‘operating’ and a ‘competing business’. Your contract can expand these terms to be very broad or apply to specific roles and businesses where it is very narrow. What is best will depend on whether you are buying or selling. As the buyer, you want the restraint to be as broad as possible (while being reasonable), and as the seller, you want it to be narrow. 

Cascading Clauses

A cascading clause protects the purchaser to the greatest extent possible. You can include a cascading clause when drafting a restraint of trade clause. A cascading clause progressively decreases, for example, three years, two years, one year. 

Also, parties must provide different cascading options for restraint periods and distances. Otherwise, a court may find that the clause has no effect because it is too broad and not reasonable. Essentially, a cascading clause acts as a fallback position if the vendor challenges the initial restraint as being unreasonable in court.

An example of a cascading clause is shown below: 

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:

  • a. 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
  • b. 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:

  • a. ten kilometres from the premises, or if this restraint area is not held to be reasonable;
  • b. five kilometres from the premises, or if this restraint area is not held to be reasonable;
  • c. three kilometres from the premises.

3. Restraint Period means each of the following periods separately:

  • a. three years from the date of completion, or if this restraint period is not held to be reasonable;
  • b. two years from the date of completion, or if this restraint period is not held to be reasonable;
  • c. one year from the date of completion.

A court will interpret restraint of trade clauses by looking at the facts of each case and prior decisions for similar businesses.

Assessing a Restraint of Trade Clause

A court will presume a restraint of trade to be void and unenforceable unless a party can justify that it is reasonable.

To be reasonable, a restraint of trade clause needs to satisfy two requirements:

  • it must be reasonable to the contracting parties; and
  • it must not harm the public interest.

Reasonableness

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

To assess reasonableness, the first step is to identify the purchaser’s legitimate protectable interest(s). A protectable interest is a property right or interest, but it can also include commercial interests. For example, interest in:

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

When a court determines whether the restraint is reasonable, several interests will be relevant. This includes the:

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

Consequences for Breaching a Restraint of Trade

If the vendor violates the restraint of trade and the parties cannot agree on a resolution, the purchaser must go to court to enforce it. A court may order an injunction (i.e. an order that stops a party from doing a particular thing) or damages. The purchaser must prove loss, and the court will generally calculate damages according to the lost income or lost profit by the purchaser.

Importantly, a court will determine whether the purchaser suffered any actual loss based on the facts of the case. 

Key Takeaways

As the purchaser, you must include a restraint that is objectively reasonable or includes a cascading clause that would allow a court to determine what is reasonable. Assessing whether a restraint of trade clause is reasonable is driven by each case’s unique facts and what both parties gain from the transaction. All parties in a transaction must protect their interests while allowing some degree of flexibility and compromise. If you require assistance with implementing a restraint of trade clause in your sale of business contract, contact LegalVision’s contract lawyers on 0800 447 119 or fill out the form on this page.

Frequently Asked Questions

How does a restraint of trade clause assist the purchaser?

When purchasing a business, you want assurance that the previous owner (the vendor) will not open up a competing business after the sale. A restraint of trade clause works to ‘restrain’ the vendor from operating a competing business within a specified period and within a specified geographic area.

What does it mean to have a ‘reasonable’ restraint of trade clause?

Your restraint of trade clause must be reasonable to be enforceable. You can assess ‘reasonableness’ by evaluating your interests (to have the vendor refrain from opening a competing business) against the vendor’s interest (the right to find employment).

What is a cascading clause?

A cascading clause protects the purchaser to the greatest extent possible. It progressively decreases, for example, three years, two years, one year. Restraint of trade clauses are often ‘cascading clauses’, which means that if a court decides that the first tier of the clause is unenforceable, a lower-tier will apply.

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