Competition

Common Law Restraints of Trade

Jane Lambert

21 Dec 2005

It is a longstanding principle of English and Welsh (and for that matter Scottish and Northern Irish) common law that a contract that restrain a party's freedom to carry on business or otherwise earn his or her living ("a contract in restraint of trade") is void for illegality unless the restriction is reasonable in that it is necessary for the protection of one or more of the parties' interests and that it is also in the public interest. Interests that have been held to justify such protection include trade secrets and goodwill. Transactions in which they occur include employment, joint ventures and distribution, particularly pubs and service stations.

The Policy

In Nordenfelt v Maxim Nordenfelt Guns & Ammunition Co. [1894] AC 535, Lord Macnaghton said at page 565:

"The true view at the present time I think, is this: The public have an interest in every person's carrying on his trade freely: so has the individual. All interference with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy, and therefore void. That is the general rule. But there are exceptions: restraints of trade and interference with individual liberty of action may be justified by the special circumstances of a particular case. It is a sufficient justification, and indeed it is the only justification, if the restriction is reasonable - reasonable, that is, in reference to the interests of the parties concerned and reasonable in reference to the interests of the public, so framed and so guarded as to afford adequate protection to the party in whose favour it is imposed, while at the same time it is in no way injurious to the public. "

This policy has been restated in numerous cases over the years but the essential doctrine remains unchanged.

Applications of the Policy

In applying this policy, the courts have developed a number of principles over the years which Lord Caplan set out conveniently in  Malden Timber Limited v McLeish 1992 SLT 727:

"(i) A covenant in restraint of trade is void unless it is reasonable in the interests of the parties and in the public interest.
(ii) Covenants between an employer and employee will be viewed more strictly by the Court than other forms of covenant where some consideration has passed.
(iii) For a restraint to be reasonable it must afford no more than adequate protection.
(iv) An employer is not entitled to seek protection against mere competition from a former employee. Trade secrets and old established customers may be legitimate objects of concern.
(v) An employee may have acquired additional skills and knowledge through his employment but that belongs to him and cannot be protected by the employer.
(vi) An employee has a duty of confidence, but once employment terminates the duty is restricted to not disclosing trade secrets and trade information.
(vii) The proper approach is to ascertain what legitimate interest the employers are entitled to protect and then to see if restraint is required."

Two cases that illustrate the application of those principles are International Consulting Services (UK) Ltd v Hart [2000] IRLR 227 where the restriction was upheld and Prosoft Resources Ltd. v Griffiths [1999] ScotCS 96 13 Apr 1999 where it was not. In Hart the claimant was able to point to a defensible interest, namely goodwill. In Prosoft it could not. As Lord Maclean observed, the defender was simply using his accumulated knowledge and experience and there was no evidence that D had retained anything in his head that could be described as a trade secret.

Difference between Restrains in Service Contracts and Other Agreements

Because the parties' bargaining strengths are unequal, covenants in service contracts are subjected to greater judicial scrutiny than those in contracts between business equals. A case that illustrates the point well is Emersub XXXVI Inc and another v Wheatley (1999) 14 July 1998 Queen's Bench Division where Wright J had to consider restrictions in the service contract of a vendor of a business. In the particular case, the judge upheld the restrictions in the service contract because they were inherently linked to the entire transaction.
 

 

Important