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What is a non-compete clause?

A non-compete clause is a term in an agreement that prevents one or both of the contracting parties from competing with the other party in certain specified ways. It can either be inserted as one of the terms of a contract or it can form a stand-alone agreement.

Non-compete clauses are sometimes referred to by similar terms including ‘exclusivity clause’, ‘non-solicitation clause’, ‘restraint of trade clause’ and ‘restrictive covenant’.

How are non-compete clauses used?

A few examples of where non-compete clauses are commonly used are:

  • Distribution agreements - manufacturers often seek to have an exclusive distribution agreement with a distributor. A non-compete clause could restrict the distributor from acting as a distributor for competing products during the course of the agreement and for a reasonable time after the termination of the contract

  • Consultancy agreements - in the case of a large contract, a business might ask a self-employed consultant to sign a non-compete agreement, restricting them from working for competing businesses. However, care must be taken to ensure that this does not constitute an unjustified restraint of trade (for more information, see ‘What is restraint of trade?’ below)

  • Business sale agreements (or asset purchase agreements) - the purchaser of a business may require that the seller does not set up or run a similar business that competes with that being sold for a specified time. This is common in acquisitions (ie sales of businesses) because most buyers would be unwilling to pay as much for a business if the seller was allowed to set up a competing business straight away

  • Supply agreements - in the case of a major supply agreement, the purchaser may ask the supplier not to supply their products to competitors of the purchaser or vice-versa

  • Employment contracts - post-employment restrictions (eg non-compete clauses) can be included as part of an employment contract (typically for senior positions). However, they need to meet certain criteria and can be unenforceable if they are not considered reasonable. Non-compete restrictions are normally found in Senior employment contracts because senior employees have access to more confidential information, company information, and potential trade secrets. For more information, read Post-employment restrictions

Are non-compete clauses enforceable?

Non-compete clauses can be enforceable, but they’re not always. Certain factors can influence whether a non-compete clause is legally enforceable, including:

  • competition law infringements - if the effect of a non-compete clause breaches any aspects of competition law, it will generally be unenforceable. Competition law (set out primarily in the Competition Act 1998) seeks to prevent companies and businesses from distorting markets and restricting competition by, for example, price-fixing, artificially sharing markets or customers, or limiting sales. If a non-compete clause has the effect of restricting competition (which is likely, as this is usually their purpose) and this is neither objectively justified nor exempt by a block exemption, it will generally be prohibited by these rules

  • duration - restrictions should not go on for longer than necessary. They should not be open-ended. A reasonable time period for non-compete clauses could be, for example,  6 months, but each case will depend on its individual facts

  • territory - extending the geographical scope of any restrictions beyond what is considered reasonable can render a non-compete clause unenforceable. Territorial restrictions are difficult to enforce as the law actively seeks to prevent businesses from distorting the market by geographic location (eg by dividing up territories)

  • reasonableness - the overriding requirement of any restrictive covenant is that it must not go beyond what is reasonably necessary to protect legitimate commercial interests. This means considering whether the non-compete clause is reasonable in the context of the parties themselves and their activities, and reasonable in the public interest

How long do non-compete clauses last?

It is important to include time limits in any non-compete clauses. Generally, the restrictions will last for the duration of the business (or employment) relationship and sometimes for a certain time thereafter. However, care must be taken to ensure that post-contractual restrictions are reasonable or they can become unenforceable. For example, an indefinite restriction would be unenforceable as competition law seeks to promote competition between businesses, which such an indefinite restriction on competition would inhibit.

What is restraint of trade?

Restraint of trade is a legal concept that applies to non-compete clauses contained in various types of agreements, including employment contracts, consultancy agreements, and sale agreements. A non-compete clause can be in restraint of trade if it prevents an individual or business from freely carrying out its trade (ie it restrains trade) - this is generally the case. 

A clause may be unenforceable under the doctrine of restraint of trade if, whilst restraining trade, the non-compete clause either: 

  • goes beyond what is reasonably necessary to protect the legitimate commercial interests of the party imposing the restriction, or

  • it is otherwise damaging to the public interest (eg by restricting someone from using their skills and experience in another job)

A court will look at restraint of trade clauses on a case-by-case basis when deciding whether they’re enforceable. If a clause seeks to impose an unreasonable blanket ban on competition, this will generally be unenforceable. 

The courts are usually more lenient when enforcing clauses designed to prevent an employee from exploiting confidential information or trade secrets. However, if a court finds that a clause is unreasonable and beyond what is necessary, it will still render it void and unenforceable.

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