Restraint of trade clauses are included in many commercial agreements and business transactions. A restraint of trade is a provision that prohibits a person who departs from a particular business from being employed, or involved within another entity within a certain territory and for a certain amount of time, in order to prevent unlawful competition with the business from which they have exited.
Restraints of trade are useful tools that enable a business owner to ensure that the valuable intangible assets of its business, such as the business model, trade secrets and customer and employee information, are protected from unfair exploitation. Typically, a restraint of trade will prevent the person subject to it from competing with the party in whose favour it is given, within a certain territory, for a certain amount of time
Restraints are frequently found in sale of shares agreements, sale of business agreements and employment contracts.
In a sale of shares agreement, a shareholder who is selling his/her shares in a company will undertake that he/she will not become a shareholder in, or be employed by, another entity conducting business in competition with the company. In the case of a sale of business (i.e. agreements where a company disposes of its business along with all of its associated assets and goodwill, as a going concern, to another entity, but the shares in the company itself are not sold) the selling company will give a restraint of trade undertaking in favour of the purchaser, as will the shareholder/s and key employees of the selling company. In both cases, the purpose of this undertaking is to prevent the seller from undermining the goodwill of the company, which is an integral part of the value for which the purchaser has paid.
In an employment contract, an employee may be prohibited from becoming employed by a competing entity. In these circumstances, the purpose of a restraint of trade is to protect the employer’s assets on which its competitive edge is based (such as its trade secrets, confidential information and client base), which a competitor could use to the employer’s detriment.
Difficulties can arise in circumstances where the party in whose favour the restraint has been given (A) decides to dispose of its business as a going concern to a third party (B). This may occur as an outright, arm’s length sale, or as a result of a restructure or reorganisation in which a business division may be transferred between companies in a group.
If the party who gave the restraint (C) breaches the restraint by competing with the business, it is B, as the new owner of the business, that would be affected by this breach and not A, who has disposed of the business and therefore no longer has an interest in it. In Absa Insurance and Financial Advisors Pty Ltd v Jonker and Another (C741/19, C742/17) 2017 ZALCCT 57 (17 November 2017), the court held that for a restraint of trade to be enforceable, the party seeking to enforce it must have an interest in the transaction or agreement, which interest must be capable or worthy of being protected in law.
When considering that it is A, and not B, in whose favour the restraint was given, B would not have the right to enforce it. Therefore, a catch-22 situation arises in which neither A nor B can enforce the restraint.
When drafting an agreement that includes a restraint of trade clause, as well as when drafting sale of business agreements, drafters need to be aware of this potential problem, which is often not foreseen at the time the agreement is signed. In order to ensure that a restraint of trade clause will protect a business and will be enforceable should the business change hands, the drafter should ensure, firstly, that the restraint itself contains a provision in terms of which the party giving the restraint agrees that in the event that the business is sold, the restraint will be enforceable by the purchaser. Secondly, if and when a sale does occur, the sale of business agreement should include a clause in terms of which the seller must cedes its rights in terms of the restraint of trade, to the buyer.
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