25th February 2014

Unfair Competition? A Fresh Look at Restrictive Covenants

Those currently negotiating the purchase or sale of a business might have been interested to see the judgment in the recent Scottish Court of Session case of Agri Energy v Ian Logan McCallion.

Mr McCallion sold his business, which supplied cooking oil and arranged for its disposal and recycling into biofuel, to Agri Energy in October 2009. The sale and purchase agreement contained a clause which restricted Mr McCallion from carrying on business throughout Scotland for a period of five years.

Following completion of the deal, Agri Energy discovered that Mr McCallion was involved in a competing business, which was established by his son. Agri sought an order from the court preventing Mr McCallion from continuing to act in breach of the agreement which Mr McCallion challenged on the grounds that the restriction was unreasonable and unenforceable.

The presiding judge noted that there were two points to consider in relation to the reasonableness of the clause:

(i)             the geographic extent of the restriction; and

(ii)            the length of time that the restriction applied for.

The judge decided that the clause was enforceable and found in favour of Agri Energy.

It is important to note that this decision turned, in large part, on the facts and circumstances surrounding the payment of the purchase price. The judge noted in his opinion that the purchase price was greatly over the price which could be attributed to the modest sum of the assets concerned in the business and therefore the purchaser was paying for an established client list and the associated goodwill. It was also observed that half of the purchase price was paid at completion with a further three instalments, the last of which was payable in October 2014 (being the five year anniversary of completion).

The judge took the view that this was indicative of the obligations of the parties being reciprocal during that period.

It was also taken into account that if Mr McCallion set up in competition to the purchaser he would not require to be situated in the North East of Scotland, where he had previously traded, in order to attract his former clients away from the purchaser. What might otherwise be considered onerous geographic restrictions were, on the facts of this case, considered to be reasonable. 

Recognition was also given to the general principle that parties have freedom to contract and are in the best position to decide what is reasonable in the circumstances of their trade. This also persuaded the judge to find that the constraints on Mr McCallion were reasonable.

This case demonstrates that, despite the generally accepted principle that restrictive covenants should be narrowly geographically and temporally defined, longer and wider restrictions can be considered reasonable in certain circumstances.

A note of caution should be sounded though. The overarching principle remains the same; parties should be free to reach agreement. Mr McCallion had received independent legal advice and was therefore not deemed to be at a commercial disadvantage in the negotiations.

In summary, while this was an interesting case, I would not recommend that purchasers attempt to negotiate lengthier restrictions than they otherwise would purely on the basis of this decision, as each situation must be considered on its own merits.  Certainly, these clauses should not be negotiated by a party without them having taken proper advice in the hope that they can challenge their validity at a later date, should they turn out to constitute a “bad bargain”. This decision highlights the importance of ensuring that you have both proper advice and are fully committed to negotiating these crucial clauses, rather than simply hoping that the other party will be too busy or have insufficient funds available to enforce their rights through the courts.

Kelly Craig
Solicitor – Corporate & Commercial 

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