Business Law · English

How to test whether or not a restraint covenant is lawful (under common law system)?

Bon, after three-year pursuing football professional career, quickly become expert in creating effective strategy in football. Then he joins John’s club as a coach for main team by signing a 2-year Agreement in which he agreed not to become the coach for other clubs in 20 years after the termination of the Agreement. Three years later, after leaving John’s club for a year, Bon signs a coach contract with another club. John, when recognised that Bon has been coaching for a club that competes the first position of the league with his club, decides to sue Bon for breaching the Agreement signed 3 years ago. Assume that if you are a judge in this law suit, which party would be in your favour?

This is a typical case in competition area, particularly, in restraint of trade. It is quite easy to recognise a restraint of trade clause in an agreement. It is the clauses that prevent a party from doing specific lawful activities in business. As general, the agreement of parties should be the first and most important source to govern the parties’ conducts, if it does not violate the law of state. But in course of time, with the development of market and economy, the lawmakers realise that the market will be efficient only if the participants in market compete fairly with others. And “anti-competition” appeared as a negative behaviour since that. One of the most controversial notions in this field is “restraint of trade”. Some legislations hold the view that this should be voided because it harms the freely development of the market and creates monopoly status, whereas other notions consider it as a useful tool to protect the interests of parties joining market. Setting aside written law system, how common law legislation adopts this notion?

One of the very classical case deal with “restraint of trade” doctrine is case Maxim Nordenfelt Guns & Ammunition Co Ltd v. Nordenfelt (Nordenfelt case). This case is about a patentee and manufacturer of guns and ammunition for purposes of war, named Thorsten Nordenfelt, signed a covenant with a company, Maxim Nordenfelt Guns & Ammunition Co Ltd (Maxim Co), to which his patents and business had been transferred that he would not for twenty-five years engage except on behalf of the company either directly or indirectly in the business of a manufacturer of guns or ammunition. Nordenfelt then signed a covenant with another company. Maxim Co sued Nordenfelt for breaching the covenant. But Nordenfelt argued that the covenant which restricts his freedom in engaging other company for twenty years, by itself, is unlawful. Once again, if you are a judge in this case, which party would be in your favour? Let’s see if you and the Lords are on the same wave length.

If you are in favour of Maxim Co, you did have an absolute answer. In this case, both Appeal Court and House of Lords held the same view, that the restraint in this case, is enforceable. Taking into account many cases from the past, the House of Lords reached a consensus that, when considering the enforceability of a restraint of trade clause, it is necessary to take into account the following factors:

  • Whether that restraint of trade is reasonable to protect the legitimate interest (in other words, lawful interest) of both parties. But how to know a restraint is reasonable of not, I will present it latter.
  • Whether that restraint harms the interest of public.

Deal with the second element first, the public interest. It may be hard to definite what public interest is. However, as general, it can be understood that a restraint causes harm to public interest, if because of the absence of a particular business activity (as a result of the restraint), the people in a specific community (where we call “public”) can not receive the goods or services which is essential for life, or can not consider the appropriate product because of lacking the diversity of products, this also means that people lose right to choose because of monopoly status. Public interest is also used to refer to the public policy or admitted customary. To sum up, public interest, appears to be flexible in each particular circumstance.

Back to the first element about the reasonableness of a restraint, adopting the restraint doctrine in Nordenfelt case, many cases later it and scholars have pointed out the assessment for the reasonableness is that “the restraint, must help to protect the legitimate interest of both parties”. It, therefore, established two important conditions, first, “the legitimate interest” and second, “of both parties”. It is not difficult to understand what “legitimate interest” means, we just need to examine the interest is lawful or not. The true issue comes from “both parties”.

At the first time when I carried out research into this area, I did confuse a lot about “both parties” condition. General thinking, if Bon is restricted from engaging in other clubs, the person has benefit in this case is definitely John, not Bon, or in alternative talk, the interest of Bon (being a coach for another team) is restricted. So, how can a restraint help to protect the legitimate interest of Bon? Actually, if we consider the issue under equity principle, John does have the legitimate interest in holding the know-how of effective football strategies because Bon agreed to give it to John. Assume that if Bon joins another club right after leaving the old one, how can John hold those know-how as secret? Till this point, you may see that it is totally necessary to restrict Bon from working for another club. That is the legitimate interest of John, but how about Bon, what is his? Now, assume that the restraint does not last for 20 years but just 1 year after the termination of the Agreement, what is the difference? It is obviously to see that if we reduce from 20-year restraint to 1 year, we will give Bon the chance to being a coach sooner, or in other words, by doing this, we do protect the legitimate interest of Bon from not being restricted so long. Therefore, the true meaning of “both parties” here, is the extent of the restraint, and as many cases pointed out, it depends on “the duration” and “geographical scope” of the restraint. But, to what extent the duration and geographical scope is reasonable to protect the legitimate interest of both parties? It depends on specific circumstances, the type of contract between parties and the economic status as well. It is another story that both I, and some of you, need to discover more.

In conclusion for a long article, a restraint of trade, under common law, is lawful if it fulfills these following factors:

  • It helps to protect legitimate interests of both parties;
  • The duration and geographical scope of restraint must be reasonable; and
  • It shall not cause harm to public interests.

Finally, with those I shared with you, I believe that you did have your own decision in case Bon v. John!

 

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One thought on “How to test whether or not a restraint covenant is lawful (under common law system)?

  1. When Bon left the club, he carried away not only his skilles, but also important infomations of the club. The restraint of trade should be there to protect the club’s interest. I think in most cases, the best duration is just enought for the information, technology, etc. to be outdate, not important anymore. In Bon and John case, 20 years is too long.

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