A business owner’s guide to post-termination restrictions
Many contracts contain post-termination restriction clauses that operate to restrict the actions of a party following termination.
Many contracts contain post-termination restriction clauses that operate to restrict the actions of a party following termination. Drafted appropriately, such clauses can usefully protect your business; if too restrictive, however, they may provide no protection at all.
Post-termination restriction clauses are common in employment contracts but are also frequently used in commercial contracts such as franchise agreements and supply & distribution agreements. During the life of any agreement, the parties are likely to share confidential information and have access to each other’s employees, customers, and suppliers. Such information is a valuable asset to any business.
The traditional types of post-termination restrictions are non-compete clauses which prevent a company or individual from carrying on business in competition with that of the other contracting party, and non-solicitation and non-dealing clauses that prohibit a company or individual from dealing with or soliciting customers, suppliers or employees of the other party following termination of the contract.
Care is needed, however, as clauses that restrain trade are unlawful. It is up to the party seeking to rely on such a clause to prove that it is reasonable to protect a legitimate business interest.
What is a legitimate business interest?
The key legitimate business interests are:
- Stability of workforce;
- Customer or supplier information (connections and networks); and
- Trade secrets and confidential information.
Such interests are considered fundamental to the running of a business and it is therefore reasonable that a company will wish to protect them as far as possible.
What is reasonable?
In order to be held enforceable a post-termination restriction clause must be “reasonable in the interests of the contracting parties and reasonable in the interests of the public”. There is both a subjective and an objective consideration in interpreting any clause; each case will turn on its own facts but a court will avoid creating a global monopoly to the benefit of one party.
It is imperative that any clause is precisely drafted and limited to what is necessary to protect the legitimate business interest. It should be sufficiently narrow in scope both geographically (i.e. to the contract territory) and in its practical effect (i.e. specific to the business activities of the party relying on it). It should also apply for a fixed period – a shorter period will be appropriate where the business operates in rapidly-changing industry.
Reasonableness is judged as at the time that the contract was entered into, not at the time of termination and so a degree of foresight is required in drafting such clauses.
Post-termination restriction clauses are contractual terms and breach of any such clause may result in injunctive action being taken to prevent further activity and a claim for damages.
A business will need to establish that it has suffered and/or will suffer a genuine loss. A typical damages claim would be for the lost profit of customers that have been lost as a result of the breach.
The only way to avoid liability for breach is to have the clauses declared unenforceable. This may be because they do not meet the requirements set out above i.e. they are greater than what is reasonably necessary to protect the legitimate business interest that they seek to protect. They may also be held to be unenforceable against one contracting party, where it can establish repudiatory or material breach of the contract by the other.
Repudiatory or material breach is a breach that is sufficiently serious to bring the contract to an end. The injured party has the right to accept the repudiation and terminate the contract. In such a circumstance, the injured party is relieved of its obligations under any post-termination restrictions.
A party wishing to claim repudiatory or material breach must ensure that acceptance of the breach is communicated effectively at the time of breach and that performance of the contract ceases, otherwise it is at risk of having waived the breach and affirmed the contract.