A restraint of trade is a mechanism used by purchasers of businesses to protect the value of their newly acquired business (specifically, the goodwill created in that business by the vendor) against improper competition.

Whilst existing pharmacies are protected to a degree from new pharmacies opening, or competing pharmacies moving within a defined radius of their business premises under the Pharmacy Location Rules (the Rules), the protection received is limited. Additionally, the Rules do not protect a pharmacist that purchases a pharmacy from:

  • A vendor soliciting their previous customer base; or
  • A vendor soliciting their previous employees and management personnel.

Accordingly pharmacists cannot rely upon the Rules to completely safeguard their interests when acquiring a pharmacy business. Instead, many pharmacists rely upon a restraint of trade clause in the contract of sale to protect their investment in a new pharmacy business.

When drafted well, a restraint of trade clause can be a significant comfort to purchasers, ensuring that their business is protected from unfair vendor’s practices.

However, restraints of trade are a sensitive tool and prone to misuse – a restraint that extends too far, or that has little relevance to protecting a purchaser’s interest in a newly acquired business faces an enshrined common law principle that the restraint is prima facie invalid because it is antithetical to free market competition.

This article will consider two recent decisions of the Victorian Supreme Court about what distinguishes a ‘good’ restraint of trade from a ‘bad’ one.

Recent Case Law – the elements of a restraint of trade

The idea that one person can legally restrict another person from conducting a business and making a living from their skills by way of a binding contract (i.e. a restraint of trade) has always sat uneasily with the judiciary, which has traditionally approached these kinds of agreement with considerable caution.

Recently, in Wallis Nominees (1), Sifris J revisited the established principles of restraint of trade. In summary of his Honour’s decision:

  • A restraint of trade always starts from the presumption that it is invalid.
  • The presumption can be disproven – if the circumstances in the particular case suggest that the restraint is reasonable (towards both parties).
  • The validity of the restraint is judged at the time it is made – not with the benefit of hindsight.
  • A restraint of trade in an employment agreement is more likely to be strictly interpreted as invalid – a restraint in a sale of business may be interpreted more broadly.
  • The person seeking to enforce the restraint has the burden of proving it is reasonable in the circumstances.
  • The restraint must do no more than provide adequate protection to the party whose benefit it is included for.
  • The court will consider all facts, documents and surrounding circumstances at the time the restraint is created.

Elements of a ‘bad’ restraint of trade

Ambiguity

As stated by Sifris J, a restraint of trade should do no more than is reasonably necessary to protect a  purchaser’s interests. Where many purchasers fall into difficulty is proving that a restraint does no-more than is necessary – where a term of a restraint of trade is unclear, the presumption that it is invalid will be very difficult to overcome.

In Brunswick Family Dental (2) this issue was addressed directly. In that case a former contractor was alleged by a business owner to breach a restraint of trade contained in its services agreement around non-solicitation of clients. The plaintiff/business owner was seeking a temporary injunction prior to trial to restrain the contractor from engaging in restrained conduct. The restraint contained unclear terms.

In the opinion of Macaulay J in that case, the business owner would have been unsuccessful at trial in proving the enforceability of its restraint for a number of reasons:

  • The relevant clause likely contained a mistaken reference to another clause
    [x], when it intended to refer to clause [y] – this made interpretation of the clause quite difficult.
  • However, Macaulay J was reluctant to simply accept that the clause should be read in another way – in his view, the Court should interpret what was actually written, not what was intended – the inadvertent slip led to ambiguities in the way the restraint was written – on the basis that it was on the business owner to prove the restraint’s meaning (including overcoming any ambiguity in its drafting), and as they could not, it was likely to be unenforceable.


Lack of Proportionality

The second head on which the restraint was likely to fail in Brunswick Family Dental was that the business owner did not prove to Macaulay J’s satisfaction, that the restraint was legitimately justified in the interests of the business. Because the business owner did not point to any contextual evidence that showed why the restraint was reasonable, and did not make a convincing argument about the connection between the restraint and the on-going preservation of the business’ goodwill, his Honour found there were considerable questions about the restraint’s enforceability.

Elements of a ‘good’ restraint of trade

By contrast to Brunswick Family Dental, the case of Idameneo (3) shows that if drafted proportionately and clearly, a restraint of trade can be a powerful tool to protect a purchaser’s investment in a business’ goodwill.

Proportionality

In Idameneo the plaintiff was a purchaser of a medical practice. Idameneo had purchased the medical practice from Doctor Deady and the contract of sale included a restraint clause that Deady would not open a competing medical practice, or provide medical services within 10 kms of the business premises for a defined restraint term.

In addition to the sale of the practice, Deady agreed to stay on with Idameneo as an employee. The term of the restraint was defined as:

  • 5 years from the date of sale of the business; or
  • 3 years from the date that Deady terminated his employment.

In October of 2013 Deady terminated his employment, and in the same month began providing medical services at a new medical practice 800m from the practice premises.

In that case, Forrest J upheld the restraint of trade, and ruled in favour of Idameneo. His Honour’s reasons were based on the following facts:

  • Idameneo had paid a considerable amount for the practice – $650,000 – in his Honour’s view, Deady had received a fair sum in exchange for his promise not to compete with the practice.
  • The restraint was clearly imposed to protect the value of the business acquired – not for any ulterior purpose.
  • The restraint was expressed in a clear way and could be easily interpreted to infer the parties intentions at the time it was made.
  • Taken in context of the demographics of the area in which the practice was located (population spread, proximity of other medical clinics, transport options), a 10km restraint area was reasonable – Deady could have comfortably relocated to a practice outside of the restraint area and continued to practice medicine.
  • Whilst Deady’s lawyers made a public interest argument – that the restraint would restrict access of the local community to an experienced medical professional – Forrest J found that by continuing to allow Deady to practice within the restraint area, there was a high likelihood that many of his previous clients would leave Idameneo’s practice, resulting in a loss of value to the business goodwill – on the balance of public convenience, it would be unfair to Idameneo to permit this.

Summary

From the perspective of a purchaser, it is ill advised to enter into a purchase of a business without the benefit of a restraint of trade clause.

Plainly, pharmacists rely upon returning customers to service scripts and local customer traffic in the vicinity of their pharmacy to generate business. These sources of income should be protected. Additionally, there is considerable goodwill in the employees of a pharmacy business, and the loss of an experienced pharmacist can be highly disruptive to a smooth transition of ownership in a business.

The fact that restraints of trade are very nuanced and require a measured approach, together with experience of comparative transactions, are good reasons for any pharmacist to obtain professional advice when entering into a purchase agreement. Pointon Partners have considerable experience advising purchasers and vendors of pharmacy businesses and advising on restraint of trade matters.

If you would like to know more about this topic please contact the author, Matt Curnow at  msc@pointonpartners.com.au

(1) Wallis Nominees (Computing) Pty Ltd v Matthew William Pickett [2012] VSC 82
(2) Brunswick Family Dental Pty Ltd v Dr Enegd [2014] VSC 325
(3) Idameneo (No. 123) Pty Ltd v Deady [2013] VSC 727

by Matt Curnow, Lawyer, Pointon Partners