When purchasing a business, it is important to make sure that certain restraints are established to ensure the viability of the business moving forward. If these are not put into place, the purchaser runs the risk of the vendor starting a competing business and taking their old clients with them, leaving the new owner with a business of significantly less value than expected. To protect both parties’ interests, contracts of sale may include restraint of trade clauses.
What are restraints?
There are two main types of restrictions in restraint of trade clauses:
- Non-compete clauses, which restrict the vendor from setting up a new similar business that may compete with the business being sold
- Non-solicitation clauses, which prohibit the vendor from poaching staff, or approaching clients or any other people connected with the business being sold
Restraint of trade clauses generally include limits on the operation of the restraints. Most commonly this would be geographical, not being able to open a business within a specified geographical area for example a 10km radius of the business, and time restraints on how long these clauses may be in operation, such as 24 months.
If the purchaser of a business suspects that the restraint of trade clause has been breached, the purchaser can sue the vendor or person who gave the restraint for losses. In general, courts are unwilling to enforce agreements that restrict an individual’s freedom to conduct business, unless it can be proved to be necessary to protect the purchaser’s legitimate business interests. The court will only enforce restraint of trade clauses to the extent that they are ‘reasonably necessary’ to protect the business interests of the purchaser, such as confidential information, intellectual property, and stakeholder relationships.
For example, it may be reasonable to restrict the vendor from starting a competing business within a 20km radius of the business, however, the court would be unlikely the enforce a clause that limits the vendor from starting a competing business within the whole of Australia. Likewise, it may be reasonable to restrict the vendor from doing this for 24 months, but not for a period of 10 years. The courts may also not enforce a restraint of trade clause if it conflicts with the public interest.
The reasonableness of a restraint should be considered carefully, and its distance or length depends on the type of business. A convenience store will not have the same restraint period as a digital marketing business.
Restraint of trade clauses can be highly beneficial to ensure the purchaser of a business gains the full benefit of its purchase of goodwill, however, it is essential to pay special consideration to how these clauses are drafted to ensure their effectiveness and ability to be enforced.
Contact us at [email protected] or 02 9307 8900 for an initial discussion for any business sale or purchase-related questions.
The blog published by Rostron Carlyle Rojas is intended as general information only and is not legal advice on any subject matter. By viewing the blog posts, the reader understands there is no solicitor-client relationship between the reader and the blog published. The blog should not be used as a substitute for legal advice from a legal practitioner, and readers are urged to consult RCR on any legal queries concerning a specific situation.