What are the main types of restrictive covenants used in business?
Non-compete clauses or agreements prevent one of the contracting parties from competing with the other party in certain specified ways. For example, restrict a distributor from acting as a distributor for competing products.
Read Non-compete clauses for more information.
Non-solicitation clauses are generally designed to prevent a business from approaching the customers of another business in a bid to win their custom. In the case of a distributor, it may also be used to prevent the solicitation of suppliers.
Non-dealing clauses are similar to non-solicitation clauses by going a step further, by preventing any solicitation of customers and prohibiting any dealings (eg even if a customer approaches the business which is the subject of a non-dealing clause, they still cannot trade with them).
Normally, this would apply to a former employee who sets up a business and tries to poach another employee (ie induce them to leave their current employer and join them in their new venture). However, it can equally apply to businesses that become heavily integrated with a client and decide they would like to take on a member of their staff.
These types of clauses are generally used where confidential information is exchanged. They prevent one party from going directly to the other party’s suppliers or clients, with the intention of bypassing (or circumventing) them and contracting directly with the business partners. For more information, read Non-circumvention clauses.
Confidentiality (in Scotland)
These types of restrictive covenants are generally designed to prevent an individual from divulging trade secrets or other confidential information to their new employer or a third party.
What kind of agreements can these be used in?
Distribution agreements - manufacturers often seek to have an exclusive distribution agreement with a distributor. Restrictive covenants can prevent the distributor from working with competitors.
Consultancy agreements - self-employed consultants may be asked to sign restrictive covenants to protect the interests of the contracting business. But it’s important to make sure that any such clauses do not constitute a restraint of trade (see below).
Sale and purchase agreements - when a business is purchased, the buyer may want to include conditions in the sale agreement which preclude the vendor from poaching any of their former employees (ie if they set up a new business).
Supply agreements - when entering into a substantial supply agreement, the purchaser may ask the supplier not to deal with any of their competitors.
Franchising agreements - as part of a franchise agreement, the franchisor may impose restrictive covenants upon their franchisee, in an effort to prevent them from using contacts made in the course of the franchising process to set up on their own.
Example of how restrictive covenants work in practice
ABC Ltd secures a distribution agreement with 123 Ltd. The agreement includes a non-solicitation clause that prevents ABC from approaching competitors of 123. However, when a competitor XYZ Ltd approaches ABC, this non-solicitation clause is ineffective; ABC can act as the distributor for XYZ as well as 123. In order to prevent this, 123 would need to have used a non-dealing or a non-compete clause.
What are the restrictions of restrictive covenants?
To be legally enforceable, restrictive covenants need to be used carefully, particularly if one of the contracting parties is more powerful than the other (eg a large company contracting with a sole trader). As a general rule, they need to be reasonable; any restrictions should not go beyond what is reasonably necessary to protect legitimate commercial interests.
Some of the elements of reasonability are duration (eg restrictions should not go on indefinitely) and territory (where the geographical scope is relevant). In the case of non-compete clauses, competition law needs to be adhered to. Finally, if used in consultancy agreements, restrictive covenants should not prevent an individual consultant from freely carrying out their trade (known as restraint of trade).