When someone sells a business, leaves a partnership, or steps back from a company they helped to build, the people who remain often want reassurance that the departing party will not simply set up in competition next door and take clients with them. 

Restrictive covenants are the legal tool used to provide that reassurance. They appear in all sorts of business agreements, yet they are widely misunderstood, and a covenant that looks watertight on the page can prove unenforceable at the very moment it is needed.

What are restrictive covenants, and where do they appear?

A restrictive covenant is a contractual promise not to do something, usually for a defined period after a relationship comes to an end. In a business context, the aim is to protect the value and interests of a business when someone connected to it moves on.

You will most often find them in:

• Partnership and LLP agreements, restricting what a departing partner or member can do after leaving.
• Shareholders' agreements and company articles, binding shareholders who sell their shares or otherwise exit.
• Business sale and purchase agreements, where a buyer wants to protect the goodwill they have paid for.
• Employment contracts, particularly for senior people with access to clients and confidential information.

The common thread is that someone with knowledge of, or influence over, a business is asked to accept limits on their freedom to act once they are no longer part of that business. 

Non-compete, non-solicitation and confidentiality: what is the difference?

"Restrictive covenant" is an umbrella term. The clauses you actually encounter tend to fall into a few distinct categories, and the distinction matters, because the courts treat them differently.

A non-compete clause is the most restrictive of all. It prevents a person from working in, or setting up, a competing business for a set period within a defined area. Because it can stop someone earning a living in their chosen field, it is the hardest type of clause to enforce.

A non-solicitation clause prevents a departing party from approaching the clients, customers, or sometimes the staff of the business in order to win their custom or tempt them away. A related non-dealing clause goes a step further, preventing the person from dealing with those clients at all, even where the client makes the first approach.

A confidentiality clause protects sensitive information such as client lists, pricing, business plans, and genuine trade secrets. Unlike a non-compete, confidentiality obligations can be more readily enforced and are often expressed to continue indefinitely where true trade secrets are involved.

Because the narrower clauses interfere less with a person's ability to earn a living, the courts are generally more willing to uphold them. A well-drafted agreement often relies on a combination, with a broader non-compete sitting behind more targeted non-solicitation and confidentiality protections.

When is a restrictive covenant actually enforceable?

The starting point in Scots law, as across the rest of the UK, is that a restrictive covenant is a restraint of trade and is therefore unenforceable as a matter of public policy. It becomes enforceable only if the party seeking to rely on it can show two things: 

1. That it protects a legitimate business interest.

Legitimate business interests typically include established client and customer connections, confidential information and trade secrets, and the stability of the workforce. A simple wish to avoid competition is not, on its own, an interest the law will protect.

2. That it goes no further than is reasonably necessary to protect that interest.

Reasonableness is weighed against several factors:

• Duration. The shorter the restriction, the more likely it is to be upheld. A few months may well be reasonable; several years rarely is.
• Geographic scope. The restricted area should reflect where the business genuinely operates. A nationwide ban for a firm trading only in East Lothian is unlikely to survive scrutiny.
• Scope of activity. The clause should target the specific activities that pose a real threat, not every conceivable line of work the departing person might turn to.

Crucially, reasonableness is judged as at the date the agreement was entered into, not at the point the dispute arises. A clause that was too wide from the outset cannot be rescued after the event.

It is also important to know that the courts do not treat everyone the same. A covenant given by someone selling a business, or by an outgoing partner or shareholder, is generally allowed more latitude than the equivalent clause in an employee's contract. The reasoning is that those parties usually negotiate at arm's length, often with their own legal advice, and the buyer or remaining owners are protecting goodwill they have genuinely paid for. Covenants imposed on employees, by contrast, are read more strictly, because of the imbalance in bargaining power.

If a covenant is drafted too widely, a court may sometimes delete the offending words and enforce what is left, but only where the clause can be cleanly severed. The court will not rewrite a bad clause to make it work, which is exactly why careful drafting at the outset matters so much.

What are my options if a dispute arises?

When a covenant is breached, or a dispute begins to loom, the options usually run as follows.

Negotiation is almost always the sensible starting point. Many disputes are resolved by agreement once each side understands its true legal position, sometimes by way of a revised set of restrictions that both parties can live with. It is faster, cheaper, and far less damaging to a business than a court action.

Where matters are urgent, for example where a former partner is actively poaching clients, the most powerful remedy in Scotland is an interdict. (You may have come across the English term "injunction"; in Scotland the equivalent court order is an interdict.) An interim interdict can be obtained quickly to halt the conduct while the wider dispute is resolved, which is often decisive in practice.

Damages may also be available to compensate for losses caused by a breach, although proving the financial loss with precision can be challenging.

Perhaps the most valuable step of all is taking advice early: ideally before signing an agreement, before allowing someone to leave, or before starting a new venture of your own. If you are bound by covenants, you need to understand what you can and cannot do before you act. Acting first and asking later can prove an expensive mistake.

How Paris Steele Can Help

Restrictive covenants are easy to get wrong, whether you are drafting them, relying on them, or simply trying to work out what you are free to do after leaving a business. 

Whether you are putting a partnership agreement together, buying or selling a business, or planning your next move after an exit, we are here to help. Talk to us today. Call our North Berwick office on 01620 892138 or our Dunbar office on 01368 862746, or get in touch online.

This article is provided for general information purposes only and is not intended to constitute legal advice. The information contained in this article is accurate to the best of our knowledge as at the date of publication. As laws, regulations, guidance, and other relevant information may change over time, the content of this article may no longer reflect the current position.

The information contained herein may not apply to your specific circumstances and should not be relied upon as a substitute for professional legal advice.

If you require advice about your own situation, we recommend that you seek advice from a qualified solicitor. If you would like to discuss your circumstances or find out how we may be able to assist, please do not hesitate to contact our team for advice tailored to your individual needs.