Restraint of trade: court of appeal rules on restrictive covenants in service agreements

In the recent case of Quantum Actuarial LLP v Quantum Advisory Ltd [2021] EWCA Civ 227 (24 February 2021), the Court of Appeal upheld the High Court’s ruling on the interpretation of restrictive covenants in service agreements and set out the legal approach in the application of the restraint of trade doctrine[1].

FACTUAL BACKGROUND

Quantum (“Old Quad”) was a company which provided actuarial services, whose largest shareholder was Martin Coombes (“MC”). In 2004, Old Quad entered into a joint venture with Robert Davies (“RD”) and others to set up RPS, a new company to carry out similar business with different clients. The principal shareholders of RPS were Old Quad and RD.

In 2007, due to MC’s desire to diversify not being met by his colleagues, the shareholders of Old Quad decided to set up a new entity (the “LLP”) to take over the businesses of both Old Quad and RPS (collectively referred to as the “legacy business”). Old Quad and the LLP formalised the arrangement by way of a service agreement, which had a term of 99 years. The service agreement contained various restrictive covenants, and clause 2.2 in particular, prevented the LLP from soliciting or obtaining instructions from a list of specified clients that the parties had agreed would continue to be contracted directly by Old Quad, rather than by the LLP (“Restraints”).

A company owned wholly by MC, New Quad, purchased the entire share capital of Old Quad and RPS. As a result, all the businesses and assets from the two companies were transferred to New Quad. The service agreement with the LLP was also subsequently novated to New Quad, and Old Quad was dissolved.

THE CASE AT COURT OF APPEAL

In 2018, having consulted its legal advisors, the LLP notified New Quad in writing that it was of the view that the Restraints unreasonably restricted the trade of LLP, and should therefore be considered unenforceable. The LLP proceeded to carry out its obligations under the service agreement under a redefined time period of “5 to 10 years”. As a result of this, New Quad sought a declaration from the High Court to bind the LLP to the original term of the service agreement, as well as to restrict the LLP from what it considered a breach of the service agreement.

The LLP countered New Quad’s claims by stating that the service agreement between itself and Old Quad was never novated to New Quad, and even if it had and that the LLP was bound by the service agreement, the Restraints would amount to an unreasonable restriction of its trade.

Having concluded that the service agreement was indeed novated between the LLP and New Quad, the High Court was asked to consider whether the doctrine of restraint of trade applied and if so, if the Restraints were enforceable under this doctrine.

When deciding the enforceability of any restrictive covenants in contracts, the doctrine of restraint of trade states that a restraint will only be considered enforceable if it satisfies the following criteria:

  • it is designed to protect a legitimate interest of the business;
  • it is not wider than reasonably necessary to protect that interest; and
  • it is not contrary to the public interest.

Based on the facts of the case, the High Court decided in favour of New Quad, reasoning that the doctrine of restraint of trade did not in fact apply to the Restraints.

Unsatisfied with the ruling, the LLP took the case to the court of Appeal in hope of overturning the High Court’s decision, arguing that:

  • the judge had failed to take into account the practicality of the Restraints and placed a disproportionate focus on the circumstances in which the parties had entered in the service agreement, and as such, he overlooked the reasonableness of the Restraints; and that
  • since the Restraints did not fall under the categories identified by Lord Wilberforce in Esso Petroleum, the doctrine of restraint should have been applied rather than the “trading society” test. The “trading society” test is only engaged if a restrictive covenant is considered to fall outside the parameter of the normal currency of any commercial or contractual relations.

COURT OF APPEAL’S RULING

In considering whether the doctrine of restraint of trade applied, the Court of Appeal set out the following questions:

  • whether the Restraints would amount to a restraint of trade in practical terms;
  • if so, whether it was appropriate to dispense the contract from the necessity of justification under a public policy test of reasonableness by reference to both public and private interests.

Taking into account the facts of the case, Carr LJ held that there was no suggestion of interference with the long-established view on the authorities that there is no single test to be applied.

Moreover, the circumstances in which the service agreement was created were highly specific and very bespoke, and as such, it fell outside what would normally be considered the “accepted and normal currency” of commercial dealings, and should therefore be considered in its own merits. Despite its individual characteristics, the court must consider whether the Restraints were fair and proper, and it found that they were.

Since public policy remains the core of the doctrine of restraint of trade, the Court of Appeal emphasised the importance of carrying out an assessment of reasonableness by reference to the facts as they were at the time the contract was entered into, rather than considering them in retrospect. A balance must also be struck between allowing the parties to negotiate and whether the restrictions were too oppressive. In this case, the Court of Appeal decided the public interest in upholding the parties’ freedom to negotiate outweighed the restrictive effect of the clause in the LLP’s ability to trade.

CONCLUSION

Based on the circumstances in which the service agreement was agreed upon, the Court of Appeal concluded that the parties had sufficient time to reflect on the service agreement before signing, and that there was no indication of the parties having unequal bargaining power. Moreover, given the particular context in which the parties had entered into the service agreement – that such agreement effectively provided the LLP with an opportunity to trade that would otherwise have not been possible. That being the case, the Court of Appeal did not find it necessary for New Quad to justify the reasonableness of the Restraints, nor to engage the doctrine of restraint of trade.

PRACTICAL TIPS

When parties are considering including restrictive covenants in commercial contracts, extra care should be taken when the restrictions are anything other than employment-related covenants or ones which are typically included in the context of mergers and acquisitions. As evident in the Court of Appeal’s decision in the case of Quantum, considerations will be given to the context and terms of the contracts, especially having taken into account all the circumstances, and whether the restrictive covenant in question could be a cause for concern for public policy and a test of reasonableness may be required.

Please see this case here: Quantum Actuarial LLP v Quantum Advisory Ltd.

For more information, and any guidance or advice on commercial contracts and on how best to incorporate restrictive covenants into your contracts, Cleveland & Co External in-house counselTM, your specialist outsourced legal team, are here to help.

[1] Please see our previous case law article on this topic: supreme court decides on restrictive covenants and restraint of trade doctrine

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