Some types of agreements are not illegal per se, as they are not in violation of any statute or legal code, but are nevertheless unenforceable because courts have deemed them to be against public policy. Public policy involves both the government’s concern for its citizens and the beliefs people hold regarding the proper subject of business transactions. The focus is what is “in society’s best interest.”
Contracts in Restraint of Trade. It is a widely held belief in economics, and in U.S. culture in general, that competition drives down prices, which is good for consumers. Thus, agreements that restrain trade, called anticompetitive agreements, are viewed as being harmful to consumers and against public policy. They also frequently violate antitrust laws. See Chapter 47 for an in-depth discussion of antitrust law.
When courts determine a restraint on trade is reasonable, however, and the restraint is part of a subordinate, or ancillary, clause in the contract, the restraint is typically allowed. Such restraints are known as covenants not to competeAn agreement not to compete against a party for a set period of time within a designated geographic area., or restrictive covenants. There are two types.
p. 370 The first enforceable type of restrictive covenant is one made in conjunction with the sale of an ongoing business. The public policy argument in favor of supporting restrictions regarding the sale of a business involves the fairness of the sale, as illustrated by the following hypothetical: Suppose you purchase a jewelry store from Ann, a well-respected member of the community, whose business has been around for many years. The people in the community know the store, and they trust Ann to provide fair exchanges. As a well-informed businessperson, you know about Ann’s good reputation and it made the purchase more appealing.
Now suppose a month later Ann opens another jewelry store a block away. Ann’s loyal customers are likely to go to her new store because they still trust her. In the meantime, Ann’s good name is no longer associated with your store, and your business suffers accordingly. You entered into the sales agreement thinking you would benefit from Ann’s good name, but in the end you overpaid for a business that lacks that benefit, because Ann took her name with her when she went into competition with your store. In the interest of fairness, courts are willing to impose restrictions preventing Ann, or others in her position, from going into immediate competition with you, or others in your position. Public policy requires fairness in business transactions, which does not occur when people profit from the sale of a business and then start a new business that destroys the one they just sold.
Remember, if the covenant not to compete is an integral part of the main agreement, not subordinate, the agreement is typically considered unenforceable and void, because it goes against public policy by creating unreasonable restraints on trade. When the covenant is subordinate, however, the specific noncompetition clause can be removed and the agreement can go forward as planned. In Case 16-2, the court had to determine the reasonableness of a covenant not to compete that was included in a separation agreement.
WILLIAM CAVANAUGH v. MARGARET McKENNA SUPERIOR COURT OF MASSACHUSETTS, AT MIDDLESEX 22 Mass. L. Rep. 694; 2007 Mass. Super. LEXIS 298
Defendant entered into a separation agreement with the plaintiff at the time of their divorce. The agreement provided in part that defendant would not accept full-time employment or open her own funeral business in Wilmington so long as the plaintiff maintained his funeral business. The trial court found that plaintiff had breached the agreement by competing with defendant by working for, and later owning, Nichols Funeral Home. On appeal, the defendant argued that the covenant not to compete was unenforceable as a restraint of trade that violated public policy.
JUSTICE SMITH: A covenant to not compete must be reasonable in time and scope, serve to protect a party’s legitimate business interest, be supported by consideration, and be consonant with the public interest…. While most covenants not to compete arise either in the context of an employment relationship or the sale of a business, there are situations which do not “fit neatly into existing standards for reviewing such covenants” which require analogy. Boulanger v. Dunkin’ Donuts, Inc., … (2004) (finding covenant in franchise agreement akin to that of covenant in sale of business). With the sale of a business, “courts look less critically at covenants not to compete because they do not implicate an individual’s right to employment to the same degree as in the employment context.” … Courts will consider whether the parties were represented by counsel in making the agreement and entered the agreement without compulsion….