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Does a restraint of trade agreement with employees lapse on the sale of the business?

In many businesses, it is important to require your employees to sign restraint of trade agreements to prevent them from resigning and then using confidential information, customer lists and trade secrets they have acquired while working for you to set up a competing business. The contractual restraint would normally bar the employees from setting up a competing business in a specified area for a specified period of time.

If your business trades as a company and a change in control of the company takes place (ie a new controlling shareholder takes over), any restraint of trade agreement that your employees have signed with the company is unaffected by the take over. The existence of the company and its contractual and other rights are not affected by the fact that shares in the company have changed hands. Hence, the company under its new controllers can enforce the restraint of trade agreements against the employees.

But what is the effect of a restraint of trade agreement with employees if you were not trading as a company and you sold the business as a going concern? Or if you were trading as a company but instead of selling your shares, you simply sold the business as a going concern? Is the purchaser of the business (as distinct from someone who has purchased the company) entitled to enforce the restraint of trade agreements against the employees?

One’s first instinct may be to think that the answer must be “no”. After all, the doctrine of “privity of contract” means that only the parties to a contract acquire rights under it and hence, only parties to the contract can enforce such rights. And in this case, the purchaser of the business was not a party to the restraint of trade agreement signed with the employees.

CONTRACTUAL RIGHTS CAN BE CEDED

However, the law recognises that contractual rights can, in many situations, be ceded (transferred) by one person to another. And it has been held that if the owner of a business sells a business as a going concern, including its goodwill, it is implicit that included in the goodwill are the contractual rights under a restraint of trade agreement. Hence, the purchaser of the business takes over those contractual rights and can enforce them against the employees. (See Botha and Another v Carapax Shadeports (Pty) Ltd 1992 (1) SA 202 (A)).

However, if the restraint of trade agreement was drafted in such a way as to confer a personal benefit on the particular owner of the business, then a sale of the business as a going concern will not result in the rights under that agreement passing to the purchaser. (See for example Davies v Davies (1887) 36 ChD 359 (CA)). It is therefore important that a restraint of trade agreement be drafted in such a way that the restraint is for the benefit of the business and not for the personal benefit of the owner. Moreover, when the business is sold as a going concern, it is advisable (so as to put the issue beyond doubt) for the contract to state explicitly that, included in the goodwill of the business, are the rights under any existing restraint of trade agreement.

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