No quantum leap in the doctrine of restraint of trade

Following a review of the authorities, including the Supreme Court’s findings in Peninsula Securities Ltd v Dunnes Stores (Bangor) Ltd [2020] UKSC 36, the Court of Appeal upheld the High Court’s findings² that the doctrine of restraint of trade did not apply to the covenants in issue and that, in any event, the covenants were reasonable.

Background

Quantum Actuarial LLP (“Quantum Actuarial”) was formed in 2007, following a reorganisation of three businesses providing services to pensions funds. As part of this reorganisation, a bespoke services agreement was executed (the “Services Agreement”) between it and two other Quantum businesses. Shortly thereafter, the Services Agreement was novated to the Respondent, Quantum Advisory LLP (“Quantum Advisory”). 

Under the Services Agreement, the existing businesses would retain their clients, and Quantum Actuarial would service those clients in return for a fee. Covenants in the Services Agreement (the “Covenants”) prevented Quantum Actuarial from, amongst other things, soliciting or performing certain specified services for existing clients of Quantum Advisory for the duration of the 99-year Services Agreement (and a further 12 months thereafter).

After operating under the Services Agreement for several years, Quantum Actuarial informed Quantum Advisory that it considered the Covenants to be an unreasonable restraint of trade. Quantum Advisory sought declaratory relief that the Services Agreement was fully enforceable. The High Court determined that the doctrine of restraint of trade did not apply to the Covenants, and that the Covenants were reasonable in any event.

The Doctrine of Restraint of Trade

In order to determine whether the doctrine of restraint of trade applied to the Covenants, the Court of Appeal examined prior authorities.

The doctrine is summarised by Chitty on Contracts as follows: “all covenants in restraint of trade are prima facie unenforceable at common law and are enforceable only if they are reasonable with reference to the interest of the parties concerned and of the public”. The doctrine was originally understood to mean that, to apply, the contracting party must “give up some freedom which otherwise he would have had³”.

However, in the recent decision of Peninsula Securities, the Supreme Court modified this analysis observing that certain covenants appear to have “passed into the accepted and normal currency of commercial or contractual or conveyancing relations”. These covenants, it held, have become part of the “accepted machinery” of certain transactions, so that “instead of being regarded as restrictive they are accepted as part of the structure of a trading society”. The ‘trading society’ test, reflects the importance of both: (i) the freedom to trade; and (ii) the enforceability of contract; but the Supreme Court noted that it is “no more than an imprecise guide”.

The Court of Appeal held that the decision in Peninsula Securities did not create a single universal test which will be determinative in all cases of whether the doctrine applies⁴; rather, each contract must be considered on its own terms and circumstances. The doctrine is “to be applied to factual situations with a broad and flexible rule of reason”.  Paragraph 60 of the Court of Appeal's judgment provides a useful summary of the relevant legal principles to be considered in this regard:

• The doctrine “is not confined to immutable boundaries or rigid categorisation” but there are “certain categories of covenants to which the doctrine traditionally applies” such as post-employment non-compete clauses;
• There are “no clear limits on the scope of the doctrine and no precise or exhaustive test can be stated”;
• There are “certain restraining provisions … which have become part of the accepted machinery of a type of transaction which have generally been found acceptable and necessary”;
• In order to determine whether restraints fall outside the range of normal, one needs to evaluate “all the relevant factors, to be assessed cumulatively”;
• Assessing whether or not trade is restrained is to be carried out “by reference to the position as it was at the time that the contract is made”;
• Applying the doctrine “depends less on legal niceties or theoretical possibilities than on the practical effect of the restraint”. It is “a question of substance not form”; and
• The doctrine can apply to restraints operating both during the contract, and post-contractually. However, “the fact that a restraint is limited to the period of the contract may be a factor in favour of excluding the doctrine (or a factor to be brought into account in favour of excluding the doctrine)”.

Where the doctrine does apply “the contractual restraints are prima-facie unenforceable but all, whether partial or total, are enforceable if reasonable”.

Reasonableness

Per Nordenfelt v Maxim Nordenfelt Guns & Ammunition Co Ltd [1894] A.C. 535, to qualify as reasonable, any covenant must: (i) afford adequate protection to the party in whose favour it is imposed; and (ii) be, in no way, injurious to the public.

The onus of establishing reasonableness first falls to the party seeking to rely on the covenant. This party must demonstrate that the covenant in question is no more than reasonably required to protect the legitimate interests of the party protected by it. If this is established, the burden of proving that reliance on the covenant is contrary to the public interest lies with the party attacking the covenant. Whether or not the covenant is reasonable is to be assessed at the time the contract was made.

The Court of Appeal's judgment makes clear that what is reasonable may “alter with the changing nature of commerce and society” and that the “motives of the party challenging the contract are immaterial”. In assessing reasonableness, the court will examine:

• The character of the business;
• Any inequality of bargaining power;
• The existence (or otherwise) of any standard forms of contract;
• Whether the restraints operate during or post-contract;
• The surrounding circumstances, including factual and contractual background;
• The duration of the agreement in restraint of trade; and
• The level of compensation.

Decision

The Court of Appeal held that the Services Agreement, correctly viewed in the context of its commercial background and rationale, was a “bespoke agreement created in very specific circumstances… fashioned to address the competing needs and interests of a group of professional people and, in particular, the practical issues involved in permitting one part of the group to enjoy the benefits of [an] established… brand and business when [they were] unable to afford a buy-out of the interests of the other group”. Negotiations had culminated in an agreement which was “fair and reasonable as among all those involved”. It was not an agreement to which the ‘trading society’ test would naturally apply and should be considered on its own terms.

If the test were to be applied, the Court of Appeal described the Covenants as “unobjectionable in any event”, noting that their timing and duration did not give rise to any legitimate cause for concern. This was underscored by the contractual acknowledgement of the reasonableness of the Covenants, and the fact that the restrictions were integral to the deal struck between the parties. Indeed, but for the Services Agreement, Quantum Actuarial, which had no pre-existing business, would not have come into existence at all: "the Services Agreement was the sine qua non of LLP's ability to carry on business at all; to speak of it nevertheless operating as some form of restraint of trade is counter-intuitive."

In the absence of “an inequality of bargaining power”, the Court of Appeal found no other features of the Services Agreement which justified, as a matter of public policy, engaging the doctrine of restraint of trade. The Court of Appeal emphasised that freedom to contract is, in itself, in the public interest and “the doctrine is not there to rescue business men and women from having entered into agreements which they may later regret”. As there was “no sensible suggestion that the practical effect of the Covenants has any adverse impact on the public interest” the public interest in holding the parties to a freely negotiated contract outweighed the effect of restricting Quantum Actuarial in its ability to trade.

There was no basis for reversing the High Court’s findings. The Court of Appeal dismissed the appeal on both grounds.  

Discussion

The Court of Appeal's judgment confirms that, when considering challenges to restrictive covenants, the Court will review the entire contractual relationship holistically. The Court is less likely to consider covenants unduly restrictive if they represent an ‘accepted’ form of covenant (i.e. those commonly found in commercial agreements), such as post-employment non-compete agreements. In these circumstances, the covenant will likely meet the ‘trading society’ test in Peninsula Securities, as a legitimate part of the contractual arrangement, rather than simply exploitation of a weaker party’s position.

Parties should take care not to lose sight of the doctrine of restraint of trade where agreeing other types of covenants. Where agreeing such covenants, each contract will need to be considered on its own terms bearing in mind the overall context of the agreement. The fact that any covenants agreed are individually negotiated will not automatically bring them outside the restraint of trade doctrine.

However, that said, in a situation where the covenant reasonably protects any legitimate business interests, and was entered into by sophisticated parties of equal bargaining power (particularly if the parties have taken legal advice), it is clear from this decision the Court will be reluctant to interfere with the parties’ freedom to contract on the basis they see fit unless the public interest is harmed.