Key Takeaways:

  • Restraint of trade refers to any activity or contract that restricts free competition or an individual’s ability to conduct business.
  • Common forms include non-compete clauses, exclusivity agreements, and price-fixing arrangements.
  • Courts evaluate the reasonableness of a restraint based on factors like duration, geographic scope, and the legitimate interest it protects.
  • Unreasonable restraints may violate antitrust laws or be unenforceable under contract law.
  • Business owners and employees should understand which restraints are legally permissible to avoid liability.

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.

Definition and Legal Significance

Restraint of trade refers to any agreement or practice that interferes with an individual’s or business’s ability to engage freely in commerce. This includes actions that limit competition, restrict employees from working in certain industries, or prevent companies from conducting business without unreasonable limitations.

Legally, restraints of trade are scrutinized because they can violate public policy by restricting economic freedom and consumer choice. For example:

  • Horizontal restrictions: Agreements between competitors to fix prices, divide markets, or limit production.
  • Vertical restrictions: Limitations imposed by suppliers or distributors that prevent free trade, like exclusive dealing arrangements.

Courts often examine these restraints under both contract law (for enforceability) and antitrust law (to prevent monopolistic practices).

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
  • Boycott
  • Imposition of minimum fee schedules

Common Examples of Restraint of Trade

Common examples include:

  1. Non-Compete Agreements: Contracts that prevent employees or former business owners from competing in the same market for a specific period.
  2. Exclusive Dealing Contracts: Agreements that require a party to buy or sell exclusively to another party, potentially limiting competition.
  3. Price-Fixing or Collusive Agreements: Competitors collaborating to set prices or limit production, often illegal under antitrust law.
  4. Territorial or Customer Restrictions: Clauses limiting where a party can operate or which clients they can serve.

These examples are evaluated differently depending on whether they serve a legitimate business interest (such as protecting trade secrets) or unreasonably harm competition.

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.

Factors Courts Consider in Enforceability

Courts assess whether a restraint of trade is reasonable by weighing:

  • Legitimate business interest: Protecting confidential information, trade secrets, or client relationships.
  • Duration and geographic scope: Shorter, narrowly tailored restrictions are more likely to be upheld.
  • Impact on public interest: Agreements that harm consumer choice or market competition are less likely to be enforceable.
  • Balance of power: Whether one party had significantly more bargaining power during the agreement.

If a restraint is found unreasonable, it can be voided under common law or considered a violation of federal or state antitrust statutes.

Consequences of Unlawful Restraints

Unlawful restraints of trade can lead to:

  • Contract invalidation: Courts may strike down the restrictive clauses entirely.
  • Antitrust penalties: Businesses engaging in anti-competitive practices can face fines or lawsuits under laws like the Sherman Act.
  • Damages for affected parties: Employees or businesses harmed by an unlawful restraint may pursue compensation.

To minimize legal risk, businesses should draft restraint clauses that are narrowly tailored, and employees should review restrictions before signing. Consulting an experienced business or employment attorney is highly recommended, and UpCounsel can connect you with qualified legal professionals.

Frequently Asked Questions

1. What is considered an unreasonable restraint of trade? Any restriction that is overly broad in duration, geography, or scope and serves no legitimate business interest may be considered unreasonable.

2. Are non-compete agreements always enforceable? No. They are enforceable only if they protect legitimate business interests and are reasonable in duration and geographic scope.

3. Can restraint of trade violate antitrust laws? Yes. Restraints that reduce competition—like price-fixing or market division—can violate federal and state antitrust laws.

4. How can businesses avoid illegal restraints? They should draft agreements that are narrowly tailored and seek legal advice to ensure compliance with antitrust and contract law.

5. What happens if a restraint of trade clause is voided? The clause is unenforceable, and in some cases, the party enforcing it could face damages or regulatory penalties.

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