Restraint of trade clauses in commercial contracts

A restraint of trade occurs where one party (Covenantor) agrees with another party (Covenantee) to restrict their liberty in the future to carry on trade with other persons who are not parties to the contract see: Petrofina (Gt Britain) Ltd v Martin [1966] Ch 146 at 180.

Restraints of trade clauses are prima facie void, however, the presumption can be rebutted if the restraint is justified because it is reasonable in the circumstances.    Note that there is a significant divide between restraints in commercial contracts and those in employment contract with the latter being widely accepted as only being enforceable for a far shorter period of time.

Regardless of their enforceability, restraints of trade are still common in a variety of agreements, including employment contracts, contractor’s agreements and commercial contracts involving the sale of business.  This article will focus on restraints of trade in commercial contracts in light of the recent decision in Devil Dog Pty Ltd v Cook [2017] WASC 27 (Devil Dog).

When is a restraint of trade in a commercial contract “reasonable”?

The onus of establishing that the restraint is reasonable rests upon the person seeking to justify its use.

In assessing reasonableness, the Court looks at the interests of the parties concerned and the interests of the public. The restraint will be reasonable if it affords adequate protection to the party in whose favour it is imposed, while at the same, structured so that it is not injurious to the public.^[1] In Nordenfelt v Maxim Nordenfelt Guns and Ammuniion Co Ltd^[2], Lord Macnaghten described “injurious to the public” as “industrial suicide” being “a man that can no longer earn his living at the trade which he has made peculiarly his own”.^[3]

In considering the scope of the restraint, the Court is looking for a definite connection between the restraint and the Covenantee’s business, trade or profession.  If the restraint goes beyond the Covenantee’s business it will almost invariably be unreasonable by reason of its width.

Three (3) things are considered in deciding whether a restraint of trade is “reasonable”:

• the geographical area covered by the restraint clause;
• the duration of the restraint; and
• the acts covered by the restraint.

What was the substance of the restraint in Devil Dog

In 2014 the defendant (Cook) sold his business, Matchtec Hydraulics, to the plaintiff (Devil Dog) for $650,000.  The contact of sale included a restraint of trade clause.  The business manufactured, serviced, and repaired hydraulic cylinders.  $A588,700 of the sale price was attributed to goodwill.

Cook signed a deed of restraint that prevented him from:

• engaging in any business that was similar to Matchtec Hydraulics;
• accepting any business from Matchtec Hydraulics’ clients; or
• interfering with Devil Dog’s relationship with Matchtec Hydraulics’ clients

for a period of ten (10) years within the geographic region of Western Australia.

Cook continued to work for the business until his resignation took effect on 30 June 2016. In July 2016 Cook began working in a competing hydraulic engineering business.  Devil Dog applied for an injunction against Cook to enforce the restraint of trade.

Was the ten (10) year restraint of trade “reasonable” in Devil Dog?

The Supreme Court of Western Australia held that Devil Dog had a prima facie case that Western Australia was a reasonable area to restrain Cook, as Matchtec Hydraulics’ clients were located in regional WA and the Perth metropolitan area.

The Court also accepted that Devil Dog had a prima facie case that ten (10) years was a reasonable period of time to restrain Cook, because:

• ninety per cent (90%) of the purchase price was attributed to goodwill, which suggested that the business had the benefit of repeat business and enjoyed some degree of customer loyalty;
• Cook had a strong personal connection with Matchtec Hydraulics’ customers; and
• the parties, bargaining at arms’ length in the context of a commercial contract, had negotiated and agreed upon the restraint period.

The Court granted the interim injunction to prevent Cook from competing with Matchtec Hydraulics’ business.  However, the Court also expressed significant reservations about the reasonableness of the ten (10) year restraint and noted that it was “at the outer edge of what may be considered to be reasonable.”  It remains to be seen whether this period will ultimately be held to be reasonable and therefore enforceable if the matter goes to a final judgment.

Takeaways

The case highlights the importance and need for careful drafting in order to protect a business’ commercial interests through restraint of trade clauses in a commercial contracts.  Just because the other party agrees to the clause at the time does not mean it will ultimately be enforceable because it may not be reasonable in the circumstances.

Links and further references

Cases

Devil Dog Pty Ltd v Cook [2017] WASC 27

Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC

Further information about restraint of trade clauses

If you are an entering into a commercial contract and would like advice on drafting and enforcing a valid and reasonable restraint of trade clause to protect your interests, contact us for a confidential and obligation-free discussion:

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances.

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