Employment Contracts and Restraint of Trade
Restraint of trade clauses are commonly found in employment contracts and in contracts for the sale of a business. The practical effect of a restraint of trade covenant is to restrain competition. Employment contracts are subject to particular scrutiny under the doctrine. In contrast to restraints on the seller of a business, employees are usually more vulnerable and have not usually received a capital sum as part of the price of the restriction.
There may be restrictions on soliciting former customers or poaching employees. There may be obligations to keep certain information secret. There may be an outright prohibition against setting up in a particular area, within a particular time in competition with the other party. Each of these restrictions is potentially subject to the restraint of trade doctrine.
Attempts by employers to restrain former employees from competing on the basis of restrictive clauses in their employment contracts are commonly challenged by the claimed invalidation of the clause under the restraint of trade doctrine. The restraint of competition is not a legitimate purpose in itself and is invalid under common law and competition legislation.
Legitimate Interests of Employer I
The employer may succeed in enforcing such clauses, provided that he has a clearly defined legitimate interest, which is protected by a reasonable clause, narrowly tailored to protect that interest. The employer may not restrain the employee from exercising the skills of his trade or profession. The distinction may not be easy to draw.
In the case of an employer-employee relationship, the employer’s legitimate interests are limited to protecting what is recognised as his property. This comprises trade secrets and may include certain confidential information.
Reasonableness is gauged by reference to the employer’s legitimate interest. In most cases, the reasonableness as between the parties is the almost exclusive ground. Exceptionally, the public interest will be a factor, such as where a particular restriction is critical to an industry or national interest.
Legitimate Interests of Employer II
In the context of employment, the employer has a legitimate interest in protecting trade secrets and certain other confidential information, which falls short of being trade secrets. This may, in some cases, include customer lists. He also has an interest in the employee’s obligations of good faith and loyalty in the course of employment.
Trade secrets need not be complex. They must, however, reflect a certain investment on the part of the employer, which justifies it being treated as being in the nature of property.
Where the information is not a specific trade secret, it may be restrained if it is derived from a breach of the employee’s implied duty of loyalty and fidelity to the employer. These cases typically involve copying of lists and other sensitive documents, while the employment relationship subsisted.
Where the confidential information is not a trade secret and does not fall into the above categories, then, it appears that even an express covenant may not protect it.
The employer may have a legitimate interest in his trade connection. In some cases, but not generally, the trade connection may have elements of protectable confidential information.
However, it is not legitimate in itself that the employer restrains an employee from competing. The employer may be able to protect against the employee competing with him, to the extent that it is a by-product of the protection of some other legitimate interest or is traced to a breach of duty while an employee.
Restraint of trade provisions may be found in partnership agreements. A partnership may have elements of a business and an employment like relationship.
Where the partner is a salaried partner, he is an employee in substance and is treated as such for the purpose of the doctrine. Where he is, in fact, a partner, the principles applicable to the sale of a business may be operative, particularly if he receives valuable consideration for the restriction.
Partners owe each other a duty of good faith. They may have a legitimate interest in protecting partnership assets and interests which requires a more particular expression of their duty of good faith. This may be effected by contractual restraints on competing with the partnership business.
Implied Duties of Employee
Employees have an implied obligation of fidelity, during the course of their employment. After employment, it is generally an implied term that employees may not disclose trade secrets or certain categories of confidential information falling short of a trade secret, but which constitutes a valuable property like interest for the employer.
The classic scenario is where an employee leaves employment taking customers and sometimes soliciting fellow employees. The employer does not have a legitimate protectable interest in restraining his employee from competing with him, much as he might like to do so. The restraint of trade in itself is not a legitimate interest for the purpose of the doctrine.
An employer has a legitimate interest in protecting his trade secrets and certain confidential information. An employer does not have a legitimate interest in restraining his employees from exercising their trade or business. The general experience and accumulated knowledge of the employee belong to him. However, the employee’s freedom may be effectively restricted where this occurs incidentally to restrictions which protect the employer’s legitimate interests.
Trade secrets may be processes, techniques or products, falling short of patents. They are typically, the result of extensive investment on the part of the employer so that the trade secret has a quasi-proprietary nature. However, a trade secret need not be expensive in acquisition or complex.
A trade secret may be such, notwithstanding that it can be compiled from other sources. The nature of the information may be such that it is more readily classified as a trade secret or highly confidential, such as to justify the equivalent level of protection
Protectable Confidential Information
Whether information constitutes confidential information capable of protection, depends on the nature of the employment. Where the employment involves information which of its nature is customarily kept confidential, such that the employee must realise its sensitive nature, it is more likely to be held to be protectable in this sense.
The employer may have a legitimate protectable interest in his trade “connection”. The trade connection refers to his customer base. He may not restrain competition generally.
Older cases appeared to allow protection of a customer base against unfair competition. The cases have allowed employers to protect their customer connection, at least to some extent, where it has been built up by investment over a prolonged period. Various services providers such as solicitors, hairdressers, milkmen, and commission based sellers, have been protected in this way. The closer the employee’s liaison and contact with the public, the easier it will be to justify a restraint.
Where information falls short of the relatively high standard of being a trade secret or quasi-trade secret, it may be more difficult to restrain. If the information was acquired in breach of a duty of fidelity, the courts may prevent its use by injunction. Accordingly, where a list of customers or other key sensitive information, which might be used in such a way as to undermine the employer, has been taken by the employee during his employment, the courts may restrain its use.
Sale of Shares and Interest in Business
A non-compete covenant entered on the sale of a business must be reasonable as between the parties and in the public interest. The same broad principles apply to the disposal of shares.
Restraints commonly restrain competition and prohibit the seller from soliciting employees and customers within a certain time or certain radius. It will be much more readily justifiable to restrain the seller of a business from competing than to restrain an ex-employee.
Restraints imposed on the sale of shares or business must be tailored to protect the goodwill. They must go no further than reasonably necessary, in order to protect the interest, in this case, the goodwill of the business concerned.
The validity of restrictions on the sellers of business will depend on the nature of the trade. In some cases, a worldwide restriction may be appropriate, where the market is worldwide. In other cases, the restriction must be more local and must be tailored to the legitimate interest concerned.
The restraint should usually be limited to the seller of the business. Restraints on employees or other participants in the business are less likely to be upheld.
Cooperative Societies and Trade Unions
The restraint of trade doctrine is not limited to contracts for employment and the sale of businesses. It may apply to any contract or arrangement by which a person is restrained in his freedom to exercise his trade or employment. The doctrine applies to the rules of society, trade bodies and trade unions.
Restraint of trade issues has arisen in Ireland in the context of co-operative society membership rules. A member may be constrained to deal with the society on an exclusive basis in relation to the supply of a product (e.g. milk). They may be penalised as members and lose their shareholding in event of breach.
The courts are prepared to uphold such agreements/rules, provided that they are reasonable. Their aims and objectives must be legitimate. In some cases, the public interest has been emphasised as a legitimate factor.
Trade unions of their nature may operate to restrain trade. The Trade Union Acts exempt most trade unions from the doctrine.
Exclusive Dealing Agreements I
An exclusive dealing or solus agreement may be put in place where members of a particular industry join together to protect their interests. There is some support for the view that some exclusive dealing arrangements are outside the common law restraint of trade doctrine. It has been held in England that the doctrine does not apply at all where at the time of contracting, the trader did not enjoy the freedom to carry on that trade at all.
The restraint of trade doctrine has long been held to apply to so-called solus agreements, whereby a retailer agrees with the wholesaler to purchase all of his supplies from that wholesaler. Agreements of this type were formerly common in the motor industry, in relation to the supply of vehicles and motor fuel.
Exclusive Dealing Agreements II
A number of Irish cases prior to the Competition Act dealt with solus agreements between oil companies and garages. They appear to remain subject to the doctrine, even after the Competition Act.
The courts have been prepared to uphold such agreements provided that their terms are limited and reasonable. The duration of the tie is an important factor. The Courts are prepared to uphold such agreements for certain periods, as reasonable in the circumstance.
Longer ties have been found to breach the restraint of trade doctrine. The House of Lords took the view that the doctrine does not apply to cases where a trader had no freedom to carry on the trade at the time when the covenant was first entered.
A number of prominent cases have involved music recording artists. Record companies may enter onerous standard form contracts with young recording artists, which tie them to onerous terms for long period. Typically, their intellectual property rights in the compositions are assigned to the record company for a prolonged period.
Some such agreements were challenged as unconscionable, the subject of undue influence or in breach of the restraint of trade doctrine. The courts examined how fair and reasonable the restriction was at the time the contract was entered. In some cases, the restrictions could be justified on the basis of grooming artists in the longer term and the high failure rate amongst signed artists.
However, in other cases, the agreements were so entirely one-sided that they went too far in seeking to protect the record company’s legitimate interest and were void under the restraint of trade doctrine.
The rules of sporting organisations are subject to the restraint of trade doctrine. Some sporting organisations regulate particular sports and associated businesses. The restraint of trade doctrine has been applied, for example to the Football Association, the British Boxing Council, horse racing authorities, the Jockey Club and the Test and County Cricket Board.
In some such cases, the courts held that where they imposed unreasonable restrictions on the manner in which trade may be conducted, they were thereby invalid. In other cases, they were upheld on that they were reasonable by their terms in order to protect the legitimate interests of the members of the association as a whole.
Resale Price Maintenance
The restraint of trade doctrine was applied to resale price maintenance agreements. These agreements were typically entered between suppliers and retailers and sought to maintain the price at which goods were resold. They effectively sought to eliminate competition to the benefit of the parties and to the detriment of customers.
At common law, many resale price agreements were upheld, particularly within voluntary associations. The primary object of the common law is not to protect against the abuse of competition. Ultimately, resale price maintenance agreements have been invalidated in most cases by the Competition Act.
Amongst the best-known agreements, The Net Book Agreement which had fixed book prices in Ireland and the United Kingdom was reformed radically after the enactment of British and Irish competition law.
The courts have generally taken the view that restrictive covenants affecting land are not subject to the doctrine. This is rationalised on the basis that the buyer is not obliged to purchase. Covenant precluding the use of the property for a particular purpose, have been held by the Supreme Court to be outside the doctrine.
A similar approach has been taken in relation to leases which contain restrictive covenants. The Courts have not generally extended the doctrine to the grant of a lease, where the lessee has no freedom to trade at that particular location at the outset.
The Courts have distinguished between one who gives up a freedom which he has and one who buys or comes to a location subject to restrictions which he agrees to or knows to apply under the existing lease. A person who buys or takes a lease had no previous freedom to trade in that place. If he takes the land on the basis of a restriction, under this rationale, he cannot complain.
The restraint of trade doctrine applies where the restrictions go beyond the use of the property and are part of a wider transaction or arrangements which apply significant restrictions. A distribution agreement with restrictive terms, may in principle be subject to the doctrine. Arrangements between motor garages and oil companies and motor garages have been long held to be subject to the doctrine.
References and Sources
Irish Textbooks and Casebooks
Clark, R. Contract Law in Ireland 8th Ed. (2016) Ch. 15
Friel, R. The Law of Contract 2nd Ed, (2000)
McDermott, P. Contract Law (2001) 2nd Ed (2017) Ch. 16
Enright, M. Principles of Irish Contract Law (2007)
Clark and Clarke Contract Cases and Materials 4th Ed (2008)
English Textbooks and Casebooks
Poole, J. Casebook on contract law. (2014) 12th edition
Stone and Devenney, The Modern Law of Contract 10th Ed (2015)
McKendrick, Contract Law 10th Ed (2013)
Chen-Wishart, Contract Law 5th Ed (2015)
Anson, Reynell, Beatson, J., Burrows, Cartwright, Anson’s law of contract. 29th Ed (2010)
Atiyah and Smith, Atiyah’s introduction to the law of contract. 6th Ed.
Chen-Wishart, M. (2015) Contract law. 5th Ed.
Cheshire, Fifoot and Furmstons, Furmstons and Fifoot Cheshire, Fifoot and Furmston’s law of contract. OUP.
Duxbury, Robert (2011) Contract law. 2nd Ed.
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Poole, J.Casebook on contract law. 12th Ed. (2014).
Poole, J. Textbook on contract law. 12th Ed. (2014)
Richards, P Law of contract. 10th Ed. (2011)
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Stone,Devenney, Text, Cases and Materials on Contract Law 3rd Ed (2014)
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Beale, H. G., Bishop, W. D. and Furmston, M. P. Contract: cases and materials. 5th ed. (2008)
Blackstone’s Statutes on Contract, Tort & Restitution 2017 (Blackstone’s Statute Series)
UK Practitioners Texts
Chitty on Contracts 32nd Edition, 2 Volumes & Supplement (2016)
The above are not necessarily the latest edition.