Restraint of Trade Clauses – What do they mean and are they legal?
10 February 2017

– Summary

A restraint of trade is a common provision in commercial contracts. They are intended to provide protection but they may not be legal.

A restraint of trade clause is a provision in a contract that prevents one or both of the parties from conducting business (trading) under certain circumstances.  A restraint of trade comprises of 3 elements; these elements restrict in the following ways:

  • Sphere of activity
  • Period of time
  • Geography

The primary purpose of a restraint of trade is to protect one or both parties from suffering some kind of loses/damages.

A good example is of a restraint of trade can be found in many employment contracts, where an employee will be restricted from trading in a similar sphere of activity to the employer when the contract ends.  Such a restraint protects the employer’s business and prevents the employee from utilising the information, goodwill, assets, etc. of the employer for the benefit of the employee or the benefit of a competitor of the employer.

A restraint of trade is legal … however, it cannot be against public policy.

“Public Policy”, for the most part, is interpreted to mean that the restraint of trade needs to “reasonable”.  If the restraint of trade is determined to be unreasonable, a Court may declare it to be illegal and unenforceable, and therefore, invalid.  A Court should declare the restraint of trade invalid before the clause can be ignored; and, the Burden of Proof is on the restrained person (in the case of employment contracts, the employee).

Whether a restraint of trade is “reasonable” depends on finding the balance between 2 legal principles (or rights) that both parties may rely on, namely:

  • Freedom of Contract
  • Freedom of Trade

A balance between these 2 principles determines the validity of a restraint of trade, which is not always easy.  In theory, the Freedom to Contract includes the right to “give up” rights/freedoms, and therefore one could “give-up” the Freedom to Trade. However, historically, the court has decided in favour of the Freedom to Trade as the prejudice the restrained party can be great.

Notwithstanding the above, a balance still needs to be found and “Reasonableness” is determined on a case-by-case basis; it focuses on individual interests in general and the particular “protectable interest” of the person contracting.  The restrained party should be able to earn a living and the restraining party should not be prejudiced (e.g. lose money; etc.) because of the restrained party.

Courts will often look at the 3 elements of the restraint of trade mentioned above (Sphere of activity; Period of time; Geography) and determine if there are too extensive; if they are too extensive, the Court’s will usually frown upon the validity of the restraint of trade.

Sphere of activity

This element might be excessive if the wording of the clause calls for a party to refrain from trading in an industry and uses very general terms.

 

For Example, an employer’s business is in the Sale of Office Equipment but the restraint of trade prevents the employee from participating in ALL sales-related activity.  Such a clause would prevent the employee from selling pharmaceuticals too; the sale of pharmaceuticals would presumably cause the employer no prejudice at all.

Period of time

This element might be excessive if the clause calls for a party to refrain from trading for a period that exceeds the reasonable period required to protect the other party’s rights.

 

For Example, a restraint of trade that calls for a party to refrain from trading in a particular industry for 5 years where 6 months would provide adequate protection to the other party.

Geography

This element might be excessive if the clause calls for a party to refrain from trading in an area that is too large.

 

For Example, a restraint of trade that calls for a party to refrain from trading in the whole of South Africa but a restraint of 10km from the employer’s store would provide adequate protection to the employer.

DISCLAIMER: THERE ARE MORE CONSIDERATIONS THAN WE CAN COVER IN THIS ARTICLE SO ONLY USE THIS INFORMATION AS A GUIDE.   THIS INFORMATION DOES NOT CONSTITUTE LEGAL ADVICE.  IT IS ALWAYS BEST TO DISCUSS YOUR SITUATION WITH AN ATTORNEY; CONTACT US AT 0861 88 88 35helpdesk@gcm-legal.com AND THROUGH THE CONTACT FORM ON THIS PAGE.

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