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Restrictions in Commercial Agreements

Restrictions in Commercial Agreements

A recent case considered by the court upheld the operation of two restrictive covenants in a commercial agreement. The first restriction operated during the term of the agreement and the second restriction operated post-termination.

The first restrictive covenant prohibited the supplier from carrying out or being involved in any similar type of business to that which it provided to the claimants. The court concluded that the claimant had a legitimate business interest which required protection - they had invested a considerable amount of effort and money in supporting the supplier.

The second restriction prevented the supplier, during the period of six months following termination, from carrying out or being involved in any similar business conducted in a similar manner to that provided to the claimants within a ten-mile radius of the principal place of business of the supplier. Here the court focused on distance and the time limit of the restriction. The court decided that the restriction was reasonable as the six-month period was standard and ten miles was, in fact, relatively modest.

Although the courts do not take as stringent an approach when considering restrictions in commercial contracts as they do in employment contracts, the recent ruling shows that the courts will only enforce a restriction provided it is reasonable in the circumstances at hand. What is reasonable in one case may not be reasonable in another, and restrictions that aim to protect more than just the legitimate interests of the business will not be enforceable.

For example, in a joint venture case, a restriction preventing the solicitation of clients and employees for a period of twelve months following termination was valid on the basis of protecting the legitimate interest of the joint venture. However, in another joint venture case, a restriction preventing an inventor from competing with the business and selling the invention was not upheld on the basis that the joint venture company was set up to own certain patent rights and this was the business of the joint venture company.

Parties may, therefore, agree to a restriction, but this does not necessarily mean that such restriction will be upheld by a court. Aside from the reasonableness of a restriction the courts will also consider other factors such as unequal bargaining power and lack of independent legal advice. In fact, tactically, a party may agree to an unreasonable restriction so that, in the event a court finds the restriction unenforceable, they can walk away from the agreement restriction-free.

However, litigation will put pressure on both parties and quite possibly be expensive which is not ideal from either party's point of view. If you want to minimise the risk of the other party walking away from an agreement restriction-free great care should be taken when drafting such restrictions and the following questions ought to be at the forefront of your mind:

  • Does the proposed restriction strike a balance between reasonableness and business protection?
  • What is the bargaining position of the parties?
  • Is the other party legally represented?
  • Are there any contractual provisions, such as a confidentiality clause, which may restrict the other party?

Ultimately, where a restrictive covenant goes further than is reasonably necessary to protect legitimate business interests then it is likely a court will deem such restriction unreasonable and unenforceable.

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