Non compete clause

When entering into a contract, it may be necessary to consider the application of non-compete clauses in order to avoid any potential disputes or obstacles to a successful and long-term business relationship.

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What is a non-compete clause?

A non-compete clause is a term in an agreement which prevents one or both of the contracting parties from competing with the other party in certain specified ways. It can either be inserted as one of the terms of the contract or it can form a stand-alone agreement.

How can it be used?

A few examples of where non-compete clauses are commonly used are:

  • Distribution agreements - manufacturers often seek to have an exclusive distribution agreement with a distributor. A non-compete clause could restrict the distributor from acting as a distributor for competing products during the course of the agreement and for a reasonable time after termination of the contract.
  • Consultancy agreements - in the case of a large contract, a business might ask a self-employed consultant to sign a non-compete agreement, restricting them from working for competing businesses. However care must be taken to ensure that this does not constitute restraint of trade.
  • Sale and purchase agreements - the purchaser of a business may require that the vendor company does not set up a similar business to that being sold within a specified time. This is common in acquisitions because most buyers would lose value in the target company if the vendor was allowed to set up a competing business.
  • Supply agreement - in the case of a major supply agreement, the purchaser may ask the supplier not to supply their products to competitors of the purchaser or vice-versa.
  • Employment contracts - post-employment restrictions can be included as part of an employment contract (typically for senior positions), but they will need to meet certain criteria and can be tricky to enforce if they are not considered reasonable. Non-compete restrictions are normally found in senior employment contracts because senior employees have access to more confidential information, company information and potential trade secrets. For further information read Post-employment restrictions.

Are non-compete clauses enforceable?

Certain factors will be taken into account in determining whether a non-compete clause is legally enforceable, including:

  • Competition law infringements - if the effect of a non-compete clause breaches any aspects of competition law, it will generally not be upheld in court. Anti-competition law seeks to prevent companies and businesses from distorting the market by means of price-fixing, market/customer sharing and agreements limiting sales/markets.
  • Duration - reasonable time limits should apply for any restrictions; they should not go on for longer than necessary or be open-ended. A reasonable time period for non-compete clauses is usually six months, but each case will depend on it's own individual facts.
  • Territory - extending the geographical scope of any restrictions beyond what is considered reasonable can render a non-compete clause unenforceable. Territorial restrictions are extremely difficult to enforce as the law actively seeks to prevent businesses from distorting the market by geographic location.
  • Reasonableness - an overriding requirement of any restrictive covenant is that it must not go beyond what is reasonably necessary to protect legitimate commercial interests. This means considering whether the non-compete clause is reasonable in the context of the parties themselves and reasonable in the public interest.

How long do they last?

It is important to include time limits in any non-compete clauses. Generally the restrictions will last for the duration of the business (or employment) relationship and a certain time thereafter. However care must be taken to ensure that post-contractual restrictions are reasonable or they can become unenforceable. For example an indefinite restriction would be unenforceable as competition law seeks to promote competition between businesses and innovation.

What is restraint of trade?

Restraint of trade applies to non-compete clauses contained in employment contracts or consultancy agreements, but can also be found in sale agreements. If a restraint of trade clause prevents an individual from freely carrying out their trade or goes beyond what is reasonably necessary to protect the legitimate commercial interests of the party imposing the restriction, then this may be considered restraint of trade. A court will look at a restraint of trade clause on a case-by-case basis but they will generally not allow a blanket ban on competition that isn't reasonable. The courts will be more lenient enforcing clauses that are designed to prevent an employee exploiting confidential information or trade secrets. However if a court finds a restraint of trade clause unreasonable and goes beyond what is necessary it will render the clause void and unenforceable.

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