Restraint of trade doctrine: when does it apply to commercial contracts?

In the case of Quantum Actuarial LLP v Quantum Advisory Ltd [2021] EWCA Civ 227, the Court of Appeal upheld a decision that certain covenants in a Services Agreement with a 99 year term did not engage the doctrine of restraint of trade. 

Where the doctrine applies, clauses in restraint of trade are regarded as void, unless they are designed to protect a legitimate business interest and are no wider than is reasonable by reference to the interests of the parties concerned and the interests of the public. Although it is well established that the doctrine of restraint of trade can apply to covenants in employment contracts and between buyers and sellers of a company, the position has always been less clear for commercial contracts.

This decision clarifies that the court will not impose the "trading society" test (adopted by the Supreme Court in 2020) in all cases, particularly where bespoke terms have been agreed. Instead, it will adopt a flexible approach in determining whether the restraint of trade doctrine applies to commercial contracts and consider each contract on its own facts.

Background

Following a complex restructuring in 2007, an LLP was set up to provide services which Quanturm Advisory Ltd (Quad) had historically provided.  The parties entered into a Services Agreement under which Quad invoiced the clients and retained 43% of fees, distributing the remainder to the LLP to cover its costs.

The Services Agreement had an initial fixed term of 99 years and contained restrictive covenants preventing the LLP from soliciting or performing services for existing or potential clients for a period of 12 months after the expiry or termination of the agreement.

After operating under the Services Agreement for several years, the LLP became dissatisfied that it was undertaking Quad’s work without profit and notified Quad in 2018 that it considered the covenants to be an unreasonable restraint of trade. Quad began proceedings seeking declaratory relief that the Services Agreement was fully enforceable. The judge held that the doctrine of restraint of trade did not apply to the Services Agreement and that the covenants were reasonable in any event. The LLP appealed.

At the time the LLP launched its appeal, the main test for deciding whether a restrictive covenant is subject to the doctrine of restraint of trade was the “pre-existing freedom test” established in Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1968]. However, part-way through the appeal, the Supreme Court delivered its judgment in Peninsula Securities Ltd v Dunnes Stores (Bangor) Ltd [2020] in which it departed from this test, instead applying the "trading society" test.  Under this test, a restrictive covenant will not be subject to the doctrine if it has “passed into the accepted and normal currency of commercial or contractual or conveyancing relations”.  Following the decision in Peninsula, the LLP argued that the trading society test applied in all circumstances, including to a new kind of contract, such as the Services Agreement.

Judgment

The Court of Appeal considered the following three questions:

• Whether or not, in practical terms, the restraints in the covenant amount to a restraint of trade;
• If so, whether or not the covenant should be subject to the doctrine of restraint of trade; and 
• If the doctrine is engaged, whether or not the covenant is reasonable by reference to the private interests of the parties and to the public interest.

It was agreed that the restraints in the covenants constituted a practical restraint of trade (in a literal sense) so as to satisfy the first question. In relation to the second question, the Court of Appeal rejected the submission that the "trading society" test is now the sole test which should be universally applied to all covenants.  If that were the case, any contract that is novel or bespoke would automatically fall within the doctrine of restraint of trade, which would deprive the test of any “meaningful value”.

In this case, the Services Agreement was a private bespoke agreement created in very specific circumstances arising out of a complex corporate restructure. It was not therefore possible to analyse whether the covenants had passed into the “accepted and normal currency” of commercial or contractual dealings. Instead, the contract had to be considered on its own terms and circumstances.

The Court of Appeal confirmed that there is “no bright line” between covenants that are properly to be treated as part of the parties' mutual agreement and those which may be in restraint of trade.  The court has to decide which side of the line the facts of any given case fall. This involves an assessment of public policy to be carried out by reference to the facts as they stood at the time that the contract was entered into and balancing the competing considerations of the parties. The judgment points out that “the doctrine is not there to rescue business men and women from having entered into agreements which they may later regret.”

Dismissing the appeal, the Court of Appeal agreed with the judge in the first instance that the doctrine was not engaged. There was no special feature of the Services Agreement that was such a cause for concern that justified requiring Quad to prove reasonableness. The public interest in holding the parties to a freely negotiated contract outweighed the effect of restricting the LLP in its ability to trade. Further, the covenants would have been reasonable had they been restraints of trade, as they were not oppressive, but rather ” fairly and properly ancillary” to the appointment of the LLP to provide the services.

Comment

This case shows that the courts are prepared to be flexible in the application of the doctrine of restraint of trade, since the trading society test (adopted in the Peninsula case) may not be easy to apply in all circumstances. Ultimately, the court will be slow to interfere with the terms of a commercial contract if it contains bespoke covenants which have been negotiated between experienced parties of equal bargaining power and form a legitimate part of the commercial arrangement.

When drafting restrictive covenants in commercial agreements (such as non-compete, non-solicitation and non-use clauses), parties should ensure that covenants protect a legitimate interest and do not go further than reasonably necessary to protect such interests.  Covenants are more likely to be unenforceable if they are broad or unbalanced, or the parties have not obtained legal advice.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at April 2021. Specific advice should be sought for specific cases. For more information see our terms & conditions.