What is a Restraint of Trade in a Sale of Business?

by LegalVision

What is a Restraint of Trade in a Sale of Business?

A restraint of trade is a common clause in sale of business agreements. The clause will protect the purchaser of the business by preventing the vendor (or business seller) from opening a competing business nearby. The restraint of trade clause may also prevent the vendor from hiring critical employees away from the business. For example, a restaurant may depend on a particular chef for its signature food. This article describes what a restraint of trade is and how the purchaser can enforce it against the vendor.

How a Restraint of Trade Works

A restraint of trade clause is a contractual provision that prevents an individual (usually the vendor) from undertaking certain defined activities for a certain period of time, in a particular geographical area.

The purpose of this clause is to protect the goodwill of a business sold by the vendor to the purchaser and prevent the vendor from setting up a competitive business to the business they have just sold. This can be very important to protect the value of the purchaser's acquisition. In many situations, the value of the business is in the employee's knowledge or goodwill.

A standard sale of business agreement usually contains a restraint of trade in the general conditions. However, the parties may amend the clause through negotiation. For example, the parties will commonly negotiate over how long the restraint lasts and the geographical area where it applies.

Types of Restraints

Restraint of trade clauses typically include two types of restraints:

Non-Solicitation

This restraint prohibits the vendor from soliciting or engaging customers, suppliers or employees of the business

Non-Compete

This restraint prevents the individual from setting up a similar enterprise that may compete with the business subject to the sale

 

The Purchaser Can Only Enforce ‘Reasonable’ Restraints

To enforce a restraint of trade clause, the business purchaser will need to apply to court. The court will only enforce the restraint to the extent that it is ‘reasonably necessary’ to protect the legitimate business interests of the purchaser.

Whether a restraint will be ‘reasonable’ will require examination of some of the following factors:

  • nature of the business;
  • location of the business;
  • amount paid for the business;
  • goodwill and assets of the business;
  • negotiations between the parties; and
  • the terms of the agreement.

 



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