Restraint of trade in commercial contracts

Quantum Actuarial LLP v Quantum Advisory Ltd [2021]

01 April 2021

Author: Anna Wroe
Practice Area: Corporate - M&A

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The Court of Appeal’s recent judgment in Quantum Actuarial LLP v Quantum Advisory Ltd [2021] EWCA Civ 227 considered the application of the legal doctrine of restraint of trade in commercial contracts. It ruled that a restrictive covenant in a services agreement between two parties did not, in the particular circumstances of that case, attract the application of the doctrine of restraint of trade. This is a useful reminder that the courts will adopt a flexible and proportionate approach when reviewing restrictive covenants and will ultimately seek to assess them, and challenges to their enforceability, in light of and against the relevant commercial background and circumstances in which they came to be negotiated and / or entered into.

What is the restraint of trade doctrine?

The basis of the restraint of trade doctrine is that covenants are generally void and unenforceable if they prevent someone from trading or carrying on business. The law has recognised exceptions to this general position where the clauses in restraint of trade are:

  • Designed to protect a legitimate business interest of the party seeking to impose the restraint;
  • Not wider or more extensive that is reasonably necessary to protect that legitimate interest; and
  • Not contrary to or inconsistent with the public interest.

Does the restraint of trade doctrine apply in commercial contracts?

The most obvious areas where the doctrine of restraint of trade have been applied by the courts are in employer-employee contracts and in contracts between the buyers and sellers of companies / businesses. The doctrine can apply more widely and the courts are often asked to consider new areas, contracts and whether the doctrine applies.

The courts will generally consider two questions: 1) whether the contract in question is actually in restraint of trade; and 2) if it is, whether in all the circumstances sufficient grounds exist for excluding the contract from the application of the doctrine.

The broad trend in deciding whether the doctrine applies has been to apply what is known as the “pre-existing freedom” test that was articulated in the majority of the House of Lords in Esso Petroleum Ltd v Harper’s Garage Southport Ltd [1966] 1 WLR 1234 (“Esso”). The essence of the “pre-existing freedom” test is that the focus should be on whether, in entering into the restriction, the covenantor would be giving up a freedom to trade, clear of restrictions. If the covenantor would be relinquishing those freedoms, then the doctrine would be engaged. However, if the covenants are simply part of a transaction which is, of itself, the basis for the covenantor to be able to trade, the doctrine would not apply – it would simply be another term of the deal.

Interestingly, one of the minority in the House of Lords in Esso had expounded a different approach / test, namely the “trading society test”. In determining whether the doctrine applied, it would depend on whether the agreement was one of a kind which “had passed into the accepted or normal currency of commercial or contractual or conveyancing relations”.

What happened in Quantum Actuarial LLP v Quantum Advisory Ltd?

Quantum Advisory Ltd, an actuarial business (“Quantum”) entered into a services agreement with a new limited liability partnership, Quantum Actuarial LLP (the “LLP”), as part of a restructure of Quantum’s business. The LLP would provide services for Quantum’s existing clients under the terms of the services agreement but clients would be invoiced by and pay Quantum. The intention was that the LLP would give Quantum the profit whilst covering its costs.

The services agreement contained restrictive covenants which included that the LLP would be prevented from engaging directly with Quantum’s existing client base for its own business or persons identified by Quantum as potential clients. These covenants were in place for the term of the agreement and for one year beyond. The term of the SA was 99 years, with the result that the restrictions on the LLP would last for a period of 100 years.

As the personnel involved in the LLP changed over time, the LLP gradually became increasingly happy with the fee arrangement, being required essentially to undertake Quantum’s work at cost for a further 88 years. The LLP made the case that the restrictive covenants were void as an unreasonable restraint of trade.

The High Court found in favour of Quantum case in the first instance. In Peninsula Securities Ltd v Dunnes Stores (Bangor) Ltd [2020] UKSC 36 (which had been decided after the trial in the Quantum case, but before the appeal) (“Peninsula”), the Supreme Court had rejected the “pre-existing freedom test” in favour of the “trading society” test.

The LLP subsequently appealed this decision to the Court of Appeal, relying, in part at least, on the basis that, with Pensinsula, the “pre-existing freedom” test had fallen away, and that the SA was sufficiently unusual that it failed the “trading society” test. The LLP submitted that there had was an inequality of bargaining power in the formation of the SA.

What did the judgment say?

Although the Court of Appeal carefully considered Pensinsula, it found that the “trading society” test could not be a universal test for the application of the doctrine. The kind of agreement or contract, and its relative novelty or otherwise, needed to be considered. If, as in this case, a commercial contract does not fall into a category or accepted and normal commercial arrangements, the question was whether there were features of the contract that are “such a cause for concern (or apparently oppressive) as to justify (as a matter of public policy) requiring the covenantee to prove reasonableness." The services agreement would be considered on its own terms.

In the circumstances of this case, the Court of Appeal dismissed the proposition that there was any inequality of bargaining power in the formation of the services agreement; it had been negotiated between experienced and highly competent businesspeople. Based on all relevant circumstances (including the commercial background, the drafting of the contract and the fact that the parties had expressed acknowledged in the contract that the restrictions were fair and reasonable), the Court of Appeal dismissed the appeal.

In this instance, the High Court had been correct in finding that the restrictive covenants in the agreement were fair and reasonable in relation to the contract’s commercial arrangements and so were not subject to the restraint of trade doctrine. Accordingly, the appeal would be dismissed.

Conclusion

This judgment provides a valuable insight into the court’s attitude towards restrictive covenants. As with the general trend of commercial contract decisions in recent years, it is clear that the courts will give significant weight to the commercial context of an agreement before striking parts of a contract out. In the present case, context was everything. It was the clear view of the Court of Appeal that the restrictions formed part of the core of the contractual arrangement. The restrictions were an integral part of the price of entry.

Further, it is a useful reminder that there isn’t a single test of universal application that the restraint of trade doctrine will not apply to bespoke contracts, it will instead be assessed on a case-by-case basis. Each contract will need to be considered on its own terms, and consideration will need to be given as to whether it contains any features which could be said to be apparently oppressive as to justify (as a matter of public policy) requiring the party seeking to impose the restriction to demonstrate its reasonableness.

If you would like any further information or advice, please contact Anna Wroe or Gerard Armstrong from the Corporate team at Carson McDowell.

*This information is for guidance purposes only and does not constitute, nor should be regarded, as a substitute for taking legal advice that is tailored to your circumstances.

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