Restraint of trade is a very old legal concept relating to the right of individuals to do business, or pursue a trade or profession, freely, without restraint.
The original case which established the concept of restraint of trade was in the 1890s in England. Gun manufacturer Thorsten Nordenfelt had sold his business, and the two parties had agreed that the seller ‘would not make guns or ammunition anywhere in the world, and would not compete with Maxim in any way for a period of 25 years.'" The case was heard by the House of Lords, which held that:
- The provision prohibiting Nordenfelt from making guns or ammunition was reasonable
- The provision banning competition 'in any way' was an unreasonable restraint of trade and therefore invalid
Restraint of trade establishes a general rule that restraint-of-trade-clauses are void except when they protect a legitimate interest and are reasonable in scope.
How Restraint of Trade Works
Any activity that tends to limit trade, sales, or transportation in interstate commerce is considered restraint of trade.
Restraint of trade applies in two different types of cases:
Contract Law: An individual or business that feels their right to trade has been violated may take their case to court claiming that the contract or business agreement is illegal. If the terms of a contract restrain trade, the contract can't be taken to a court to be heard (as a lawsuit) because it's illegal.
Government Regulations: Restraint of trade may also be in violation of government regulations, as in the Sherman Antitrust Act of 1890 and other antitrust laws. In addition, some state laws won't allow agreements that put restraints on competitive business activity.
For example, the Sherman Antitrust Act includes a section on restraint of trade, which says, in part, that, "Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal."
Restraint of Trade and Non-Compete Agreements
Restraint of trade is an issue in non-compete agreements and other restrictive covenants, including non-solicitation agreements and non-disclosure agreements. In a non-compete agreement, an employee or business owner accepts an agreement (sometimes for compensation) not to compete with the former employer or new business owner within a certain area and type of work for a specific period of time.
Non-compete agreements are not inherently illegal, as long as they are reasonable and do not infringe on an individual's right to do business. The court looks at what's reasonable, considering all the factors of the situation. If a court views a non-compete as unreasonable, it is usually based on the principle that it constitutes restraint of trade.
In order to consider whether a contract represents restraint of trade, a court will look at three factors:
- Length of time: A contract restricting someone from setting up a competitive business for 25 years is an unreasonable length of time
- Geographical area: For example, if a business non-compete clause restricts competition "anywhere in the world" that's unreasonable
- Scope of work: The broader the scope of work, the more unreasonable. For example, a doctor restricting anyone who practices any form of medicine is unreasonably restricting trade
Types of Non-Compete Agreements
Non-compete agreements come into play in several circumstances:
- An independent contractor or employee is asked to sign a non-compete agreement upon employment. The non-compete may come into play during the employment term or it might continue after the end of the employment or contract
- A business might be for sale and, as part of the sale terms, the seller agrees not to compete with the new business
For example, an employment contract provision that prohibits a former employee from setting up a competing business for five years within a 100-mile radius of the former employer would likely be declared void because it constitutes restraint of trade. On the other hand, if the restricted area was smaller and the time period shorter, the contract provision might be upheld.
Every restraint of trade case is different. It's impossible to know ahead of time how a court might rule on a restraint of trade case; the circumstances of each case are unique.
Non-Compete Agreements in U.S. States
U.S. states have varied widely in their treatment of contracts which include non-compete agreements.
California allows no non-compete agreements in contracts. The California Business and Professions Code says, "Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void."
Florida law, on the other hand, states that a contract that restricts or prohibits competition isn't prohibited as long as the contract is reasonable in time, area, and line of business.
You can search your state's legal code to see how the state views restrictive covenants in non-compete agreements and other restrictive covenants.