Restrictive Covenants in Commercial Contracts: Are They Enforceable?

Restrictive covenants, such as non-compete clauses, are common in commercial contracts to protect a business’ interests (such as confidential information and relationships with customers and suppliers), as well as its ‘goodwill’ and reputation.

In England and Wales, however, such covenants are subject to strict legal tests, intended to ensure that such restrictions are reasonable, proportionate and enforceable.

What are Restrictive Covenants?

In terms of commercial contracts, restrictive covenants are provisions in a contract that are intended to limit a party’s actions throughout the duration of the contractual relationship and/or after the contract ends. They are similar to post-termination restrictions often found in employment contracts; however, in an employment contract, the restrictions are imposed on the employee. In commercial agreements, though, the restrictions apply to one or more party to that agreement.

Typical examples include:

• non-compete: preventing a restricted party from setting up or being involved in a competing business (usually, within a defined geographic area and/or for a prescribed period of time);

• non-solicitation: prohibiting a restricted party from making contact with or approaching clients, customers or employees (as the case may be) with a view to soliciting or enticing them away from the business or reducing their work with that business – this is often coupled with a ‘non-circumvention’ (see below);

• non-dealing: separate from the prohibition on soliciting clients, suppliers and/or employees away from a business, non-dealing prevents a restricted party from having any business dealings with certain customers, suppliers and/or employees – thus preventing those customers, suppliers or employees from making approaches to that restricted party unsolicited; and

• non-circumvention: preventing the restricted party (a contractor) from cutting your business out of the transaction and dealing/contracting with customers or suppliers directly (often, to avoid paying commission/fees or with a view to obtaining a cheaper deal).

Legal Tests for Enforceability

English courts treat restrictive covenants as restraints on trade. As a result, they are prima facie void unless otherwise deemed reasonable.

To be enforceable, restrictive covenants must:

1. protect a legitimate business interest (e.g., trade secrets, customer connections);
2. be reasonable in scope, duration, and geographic area; and
3. not be wider than necessary to protect that interest.

It can often be difficult to determine what would be a reasonable restriction on trade; it is therefore advisable to have your commercial contracts prepared/reviewed by an expert commercial lawyer to ensure that they adequately meet your business needs and achieve their aim.

Similarly, if you receive a contract from a third party, it is always advisable to have the agreement reviewed by an expert commercial lawyer to ensure that they do not expose you to unnecessary risk.

Key Considerations in Drafting

Whilst it is always advisable to have your commercial agreements reviewed by an expert commercial lawyer, here are some key issues to look out for when negotiating restrictive covenants in those contracts:

• Duration – case law suggests that the courts will typically find that restrictions for a period of between six months and two years will be reasonable, depending on the industry and circumstances relevant to that specific agreement;
• Geographical scope – restrictions must be limited to the area where the business operates or where it otherwise has legitimate interests. Cast the net too wide and you will find that your restrictions are unlikely to be enforceable;
• Clarity – ensure that you use precise language consistently to avoid ambiguity as vague terms risk unenforceability;
• Severance clauses – ensure that your agreements include severability (often called ‘blue pencil’) clauses that allow the courts to modify or sever unreasonable provisions in the agreement to preserve the remaining parts of the agreement; otherwise, the entire agreement could be void.

It is also important to note that, unlike with consumer or employment contract, where two commercial parties enter into a B2B agreement, the courts will not intervene if they believe the parties had a fairly equal bargaining position, the terms were brought to their attention, and they had opportunity to review (and take legal advice) on the same. The view of the courts in England and Wales is that businesses are free to enter into whatever agreements they like, however unreasonable (or unfairly weighted in one party’s favour) those terms might be. It is therefore imperative to get your commercial agreements reviewed by an expert commercial lawyer before entering into them.

Conclusion

Restrictive covenants are powerful tools but come with legal risks (and costs) if poorly drafted. To protect your business whilst ensuring enforceability of terms, you should seek expert legal advice.

At Neathouse Partners, we have expert commercial contract lawyers available to provide tailored drafting and review of commercial agreements to protect your business’ interests and reputation.

FAQs on Covenants in Commercial Contracts

Q:  Are all restrictive covenants enforceable in commercial contracts?

A:   No; only those that are deemed reasonable, and which protect legitimate business interests, will be enforceable. It is ultimately the courts that determine whether these provisions are reasonable/enforceable or not.

Q: How long can a non-compete clause last?

A: There is no definitive answer to this question but, typically, up to 12-18 months post-termination is considered reasonable, but shorter durations are often preferred as the shorter the duration, the more likely the provisions are to be enforceable. In any event, it will depend on the facts of the matter, and you should take specific legal advice on the same before signing any agreements.

Q:  Can I enforce a restrictive covenant against a former consultant/contractor?

A:   Potentially, but the covenants must meet the reasonableness test and be clearly drafted.

Q: What happens if a restrictive covenant is too broad?

A:  It may be unenforceable, either in full or in part, and the courts may “blue pencil” the provisions to remove unreasonable sections depending on how the contract is drafted.