Restrictive covenants in commercial contracts can provide crucial protection if you’re concerned about another business you trade with targeting your clients or poaching your employees.
These contractual clauses help prevent your counterparty from engaging in specific commercial activities that could harm your business. However, for restrictive covenants to be effective and enforceable, they must comply with strict legal requirements, such as protecting a legitimate interest (e.g., maintaining client relationships). Ensuring these clauses are properly drafted is essential to relying on them when needed.
Our commercial contract experts examine how to create tailored clauses that safeguard your business from risk.
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What risks can restrictive covenants help prevent?
Imagine your consulting business relies on a key client that provides a significant share of your annual revenue. Over time, this client builds a strong relationship with your top consulting team, who are vital to help them in delivering their projects.
Without warning, the client offers your key staff in-house positions, and they accept. This leaves your business without its most valuable talent. As a result, the client stops using your services, which means a significant loss of revenue, your top team gone and a big hit on your bottom line.
Your business could have taken proactive preventative steps by using restrictive covenants to help you prevent this type of scenario. By including key clauses such as non-solicitation or non-poaching provisions in your client agreement, you may have deterred the clients from taking your employees or required them to obtain your consent before hiring. If the client breached these restrictions, your business could have had strong legal remedies to enforce your rights.
Although this scenario may sound low risk, it can happen – so it's important to think ahead to mitigate risks, as prevention is always better than cure.
How do restrictive covenants work in practice?
Restrictive covenants are clauses in commercial contracts that limit what a party can do, to protect your business interests. The primary purpose of a restrictive covenant in a commercial contract is to restrict the other party from engaging in certain commercial activities.
Your business can include these clauses in agreements as a risk prevention tool, e.g. where you believe there is a risk of harm to your relationships.
Restrictive covenants can apply to a wide range of agreements (e.g., for the sale of a business, partnerships, joint ventures, agencies, franchises, supply arrangements, or land).
Depending on your needs, your business can use different types of restrictive covenants, with some common types including:
- Non-compete: A non-compete restrictive covenant states that one party to the agreement is restricted from competing with the other party to the agreement - this is typically drafted to cover specific activities, locations and for a set period of time.
- Non-solicitation of employees: These restriction provisions will restrict hiring activities, preventing a party from soliciting employees or contractors from the other party. It’s also possible to have a no-employment restriction stopping employment of staff.
- Non-dealing: A non-dealing restrictive covenant is designed to prevent one party to the agreement from having a business dealing with the customers or prospective customers of the other party. It’s also possible to include a provision restricting a party from soliciting key, restricted suppliers.
- Non-poaching of a party’s customers: A non-poaching restrictive covenant is designed to protect customers of the business and will state that one party to the business agreement will not solicit or entice customers for a specified period of time.
If a restrictive covenant is breached, your business may be able to take various steps for enforcement. For instance, you may be able pursue remedies such as applying for an injunction to stop the breach, or claiming damages for financial losses caused. You should seek urgent legal advice from dispute resolution solicitors should this occur, and you need help understanding your best options, depending on the circumstances of the breach.
Drafting restrictive covenants
Restrictive covenants in commercial contracts will only be effective if they’re valid and enforceable. Courts will presume that these clauses are unenforceable as restraints of trade unless they protect a legitimate business interest and are drafted no wider than necessary to achieve that aim. Courts will examine the enforceability of restrictive covenants by analysing their purpose and whether they protect legitimate business interests.
When you're drafting restrictive covenants, you’ll need to consider the specific commercial context and tailor the restrictions to address particular risks.
Some of the key considerations for effective drafting include the following:
- Restrictive covenants need to balance duration, scope, and geographical reach. The duration should align with the nature of the business. Similarly, you need to make sure the scope of the restriction must directly relate to the business's products or services and the legitimate interests being protected. For instance, a technology company may justify a one-year restriction due to the fast-changing industry, whereas a professional services firm may require a longer restriction to protect goodwill.
- Geographical limitations are very important. Apply restrictions only to areas where the business operates or has legitimate interests. Broader geographic restrictions that do not align with the business's operations are unlikely to hold up in court.
- Well-crafted restrictive covenants safeguard business interests and minimise court challenges. To enhance enforceability, you should draft each restriction as a separate clause or sub-clause. This approach allows the courts to remove unenforceable provisions without affecting the remaining terms.
What happens when a restrictive covenant is disputed?
The courts will typically assess the reasonableness of a restrictive covenant on a case-by-case basis, considering the specific circumstances of each dispute. They'll weigh the competing interests of the parties involved to determine whether the covenant is enforceable. This highlights the importance of correctly drafting restrictive covenants and contracts to ensure they’re enforceable and effective.
Seeking legal advice early ensures covenants are fair, reasonable, and more likely to be enforceable. Well-crafted restrictions can also streamline deals, as counterparties are less likely to resist terms that are overly burdensome on their business activities. Clear and reasonable covenants further reduce the risk of ambiguity, helping to avoid disputes that could escalate to court.
Help with your restrictive covenants
Restrictive covenants must be carefully tailored to your business's unique needs, as unreasonable restraints on trade may be void and unenforceable. Legal advice ensures restriction clauses are properly drafted, legally sound, and fit for purpose.
Expert guidance is also crucial when agreeing to contractual restrictions, ensuring terms are fair, workable, and not overly restrictive.
Well-drafted covenants help mitigate risks, safeguard your interests, and provide peace of mind. If you need assistance, our commercial team is here to help.
