Restraint of trade or valid non-compete clause?

A recent Scottish appeal court decision considered whether a non-compete clause in a business sale was a valid restraint of trade.

Background

In June 2016, the parties entered into a share purchase agreement (SPA) whereby PMAC Scientific Ltd purchased the issued share capital of Gamm@chek International Limited, a company which specialised in flood member detection services to the oil industry.

The contract provided for payment of elements of the purchase price at varying times and on varying conditions being met. The initial element of the price was paid on completion.

However, the secondary consideration, as referred to in the SPA, was not paid when due. In this action the appellants, Mr and Mrs Nekrews, demanded payment of that sum. In response, the respondent argued that payment was no longer due because the appellants were in breach of contract. The respondent counterclaimed for damages arising from the alleged breach of contract.

Why breach of contract?

Broadly, clause 9 of the SPA provided that Mr and Mrs Nekrews should provide that no associate of theirs should engage with and/or solicit certain persons, thereby acting in competition with the respondent, for a period of three years post-completion of the SPA.

However, an associate was defined at clause 1.1 of the SPA as a party who is connected with the contracting party. In this case, the associate was Mr Nekrews’ brother.

The respondent argued that the Mr and Mrs Nekrews were in breach of the SPA as Mr Nekrews’ brother had undertaken acts which were prohibited by clause 9 of the SPA through a limited company in which he owned 50% of the shares.

In the first instance, the Nekrews were unsuccessful in respect of the three arguments they raised. On appeal, they argued that the respondent could not rely on clause 9 of the SPA as this was a restraint of trade. The respondent’s position was that the provisions were nothing to do with the restraint of trade concept.

Decision of the Court

The Sheriff Principal examined the legal meaning of restraint of trade. He noted that as a general rule, every person was entitled to carry on business freely, and any interference with that was contrary to public policy as a general rule and therefore unenforceable. The only justification is if the restriction is reasonable in reference to the interests of the parties concerned and the public.

Further, the judge found that it is not always necessary for a contract to restrain trade (as a matter of law) it must contain a compulsitor on one of the contracting parties or indeed other parties to do some act that is a restraint. The restraint of trade in this case was voluntarily entered into.

In this case, though, the judge found that there was no loss of liberty by Mr and Mrs Nekrews. Rather, they just agreed to try to secure the co-operation of third parties, which did not engage the concept of the rule of restraint of trade. The appeal was dismissed.

Conclusion

Non-compete clauses or covenants are most commonly seen in employment cases, where they will be interpreted carefully and narrowly (and if not reasonable will not be enforceable). This case concerned a particular type of non-compete clause which is commonly seen in business sale agreements and should be enforceable. Good drafting is key and then ensuring the provisions of the contract are observed to avoid pitfalls.

MacRoberts can advise on all aspects of such drafting and enforcement. Please contact us for further details.

This article was co-authored by Ryan McLaughlin.

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