Define Restraint of Trade: Everything You Need to Know
It is something you can do to better understand situations wherein you are unable to do business as usual because of the actions of another party.3 min read
2. Types of Restraint of Trade
3. Reasonableness of Restraint of Trade
Define restraint of trade is something you can do to better understand situations wherein you are unable to do business as usual because of the actions of another party. You also need to know about this practice if you are restricting another company or individual from performing certain business activities. In order to be legal, restraint of trade must be regarded as reasonable, which is determined based on a number of considerations. There are also illegal restraints of trade, such as territorial impositions and boycotts.
What Is Restraint of Trade?
Any activity that stops a company from doing business as it normally would is called restraint of trade. While some restraints of trade are illegal, others are lawful. For instance, it is legal to ask your employees to sign non-competition agreements, if the agreements are reasonable and enforceable in your state.
A restraint of trade can be a legal agreement between an employer and an employee or a buyer and a seller that prevents the employee or seller from performing a similar business activity with another party within a certain geographical area and specified timeframe. The purpose of this practice is to protect proprietary information or trade secrets, but it is only legally binding if it is reasonable to the party it is made against and does not violate public policy.
Any business owner who feels that another party has violated his or her right to trade may file a restraint of trade lawsuit.
Types of Restraint of Trade
In general, there are two categories of restraint of trade: vertical restraint and horizontal restraint. A vertical restraint occurs when a company acquires control over another business that used to be its customer or supplier. The controlling company has the right to impose certain anti-competitive restraints on the business it acquired. Some examples of vertical restraint of trade include:
- Building a monopoly
- Coercing another business to refrain from competing with your company
- Illegally obstructing a business deal
A horizontal restraint involves creating a price-fixing agreement, which is highly illegal. Other illegal practices that are similar to a price-fixing agreement include:
- Bid rigging
- Territorial imposition
- Imposition of minimum fee schedules
Reasonableness of Restraint of Trade
If the act of interfering with a contract damages a company's reputation, then it may result in a restraint of trade claim. However, certain acts may seem legal even if they lead to a restraint of trade claim.
For example, the owners of two competing businesses discussing their pricing strategies over a round of golf, have the freedom to speak their minds. While they may not explicitly express their intentions, the subtext of their conversation may be interpreted as a price-fixing conspiracy, if that is eventually the outcome of the conversation. In the event that the price-fixing causes a third competitor to go out of business, that company has the right to sue for restraint of trade.
In some cases, a restraint of trade is indeed legitimate and enforceable in a court if it is regarded as reasonable. In order to be reasonable and therefore, legally binding, a restraint of trade must meet a number of requirements, including:
- Must serve a legitimate interest
- Must be limited to that interest
- Must not violate public interest
For instance, a manufacturer may work out an agreement with a distributor to limit its service area to a specifically defined territory. Technically, this is a restraint of trade, but it is considered reasonable because it serves a legitimate purpose and does not violate public interest.
Also, a non-competition agreement, which obligates an employee to refrain from directly competing with the employer for a specified amount of time following termination, is legally enforceable in certain states, as long as it is reasonably limited in scope and protects a legitimate interest. For example, the employer may want to use the non-competition agreement to protect his or her business connections, which is a legitimate purpose. However, the agreement needs to be limited in type of work, duration, and location.
Although a non-competition agreement obviously restricts trade, it is regarded as reasonable and legally binding in the courts in many states because it helps protect proprietary information.
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