Exercising Restraint

What business owner in his or her right mind doesn’t want to restrict competition? Especially if it’s coming from a trusted employee or the person who sold you the business!

So which of the following business owners do you think succeeded?

A. The Putaruru food store owner whose employment terms prevented his store manager from working for any similar business within a 25km radius of the store for 3 years?

B. The purchaser of a Hamilton café (who had paid $327,000 for goodwill) under a contract restricting the vendor from opening a hospitality business within a 10km radius?

C. The purchaser of shares in a large Auckland printing company (who paid $2.7 million for goodwill) under a contract preventing any of the vendor parties from competing?

These are actual examples selected from over 20 reported restraint of trade or restrictive covenant cases heard in New Zealand courts over the past year.

The correct answer is B. Why did that business owner succeed and the others fail?

Restrictive or restraint of trade covenants can be very useful tools for business owners - if they work. However the high level of failure in practice points to a wide-spread lack of understanding of these potentially valuable intangible assets.

The court’s starting point is that covenants in restraint of trade are contrary to the public interest, and are presumed void unless reasonable. What is reasonable depends on the surrounding circumstances.

On the other hand, the law will generally uphold restrictive covenants preventing the business’s proprietary and/or confidential information from walking out the door when employees leave.

Coming back to the examples above:

A. The Putaruru store owner failed to prevent his ex-manager from working for a nearby competitor because:

He could not identify the proprietary information he was supposedly trying to protect; and

Even if he had, the term of the restraint was unreasonable and could never have been more than 6-12 months at most.