To define restrictive covenant, you first need to understand that it can be used in a variety of formats. In some cases, it is used in a deed to limit the buyer from using a piece of property for particular purposes. No restrictive covenants are legal when they are based on race.

What Is a Restrictive Covenant?

This type of covenant is also commonly used in financing documents and employment contracts. When used in the latter, it prohibits the employee from performing certain actions after his or her employment has ended. For example, some companies prohibit employees from poaching other employees to start their own businesses.

There is also such a thing as a noncompetition covenant, which is viewed as reasonable in the eyes of the law as long as it:

  • Isn't injurious to the public
  • Does not put any type of undue hardship on the employee
  • Is in an amount that is necessary to provide protection for the employer

A covenant, in its simplest form, is a promise that is outlined in a contract. A restrictive covenant simply means a person or something is prohibited from performing a certain action.

According to the actual Latin definition of covenant, it means to "come together." When people agree to covenants, it means they are willing to abide by the terms set forth. A restrictive covenant, however, is highly scrutinized by some because states believe it has the potential to limit trade possibilities.

Are Restrictive Covenants Legal?

Although restrictive covenants are not highly favored by some, they are not considered illegal. But in some cases, there have been restrictive covenants put into effect that have negatively affected individuals' abilities to do business. When this happens, it is up to the court of law to decide whether the restrictive covenant should stay standing.

A restrictive covenant always asks a party to give up something; this is referred to as the consideration. In order for the covenant to be legitimate, whatever is being provided in return for giving up the consideration should be equal in value.

What Are the Common Types of Restrictive Covenants?

Generally, the most common restrictive covenants are found in the employment industry. Employment contracts tend to have some type of restrictive covenant that prohibits employees from taking part in certain actions. This is especially common when an employer has heavily invested in an employee, whether by paying for costly training or awarding the employee bonuses.

It's not uncommon to see these types of covenants among partnerships, where non-solicitation terms are outlined. In some instances, they are referred to as non-disclosure provisions. You will see this usually when new partnerships are formed. For example, a new owner of a business may have a desire for the former owner to sign a contract stating he will not compete in the sale of a company. The new owner might also have a preference for the new owner not to perform certain actions, such as soliciting existing customers.

A restrictive covenant of this type would outline that the new business owner cannot:

  • Take part in certain types of business
  • For a specified amount of time
  • Or in a specific area

A non-solicitation agreement is often used to restrict a new business owner from taking part in specific types of marketing and employment activities. For example, the new business owner must agree not to solicit any of the former owner's employees. A non-disclosure agreement, on the other hand, is directed more toward restricting certain types of communications. For example, a new business owner will not be able to disclose trade secrets or specific activities that the business takes part in.

When restrictive covenants are used in real estate transactions, they serve as legally binding contracts and are included in property deeds. A common type of restrictive covenant seen among real estate transactions is when a seller prohibits the new owner from conducting certain types of activities, such as selling alcohol.

In some cases, the covenants are simple. In others, they are extremely complex. And if a covenant is broken, there may be levy penalties that are enforced upon the party that failed to stay in compliance with the restrictions outlined in the covenant.

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