Understanding Confidentiality and Non-Compete Clauses

04 Apr 2024

Confidentiality clauses and non-compete clauses (or restrictive covenants) are tools used by buyers to protect valuable parts of the business they are acquiring. These clauses are inserted into share and asset purchase agreements to control the flow of sensitive confidential information and restrict what sellers can do when they move on from the business, post-completion.

What is the Purpose of a Confidentiality Clause?

A confidentiality clause should do what it says it does on the tin; protect confidential information. It should define confidential information, and restrict how this is managed, controlled, and disbursed.

But what is confidential information? This will depend on your business and your industry. Broadly, it’s ‘trade secrets’’ and things like confidential customer lists. You’ll need to be able to specify exactly what you mean by ‘confidential information’ for the clause to be enforceable.

Not all information is confidential, and if a confidentiality clause is drafted too widely, then it may be voidable and of no effect. Therefore, you need to think carefully about what is genuinely confidential; what information is it that you are trying to protect and why?

What is the Purpose of a Non-Compete Clause?

A non-compete clause prevents a seller from setting up a business on their own which directly competes with the business they sold to a buyer, or going to work for a competitor of that business.

There’s usually a time limit specified in the clause, so that you only restrict the seller’s choices for a defined period of time post-completion (ie; during the six-month period immediately preceding completion).

Problems with Non-Compete Clauses

You might be thinking that a non-compete clause sounds like a draconian imposition on a person’s freedom and choice. There is some truth to this, but consideration also needs to be given to balancing the tension between protecting the value of the assets a buyer is acquiring vs. managing a seller’s plans following their exit from the business they are selling. As there is a price to pay for this, the art is in striking the balance between the two competing interests.

In May 2023, the UK Government undertook a further review of non-compete clauses in contracts of employment, to find out whether they unfairly hinder workers from moving freely between employers, and restrict the development of innovative ideas. While there is a distinct difference between the use of non-compete clauses in employment vs. a commercial contract, the key findings provided some useful discussion on the prevailing sentiment about the enforceability of these types of clauses. Broadly, it was found that:

Non-compete clauses in employees’ contracts are unlikely to be enforceable.
Employers still routinely include non-compete clauses to have a deterrent effect.
There is no provision in the UK employment statutory framework for non-compete clauses.
At common law, there are few constraints on the use of non-compete clauses, hence why they are still routinely used.

All of the above considered, it was proposed that legislation should be introduced to place statutory limits on the use of non-compete clauses.

If the above change occurs, it is likely that this will have an effect on the use and enforceability of non-compete clauses in commercial contracts.

However, there needs to be balance between protecting the legitimate business interests of the buyer. When a large part of a business's value is in its customer base and confidential information, the consideration a buyer pays for these assets must be well protected, so that they retain (as far as possible), their value post-completion.

The general rule is that non-compete clauses will be allowable, so long as they are no wider than reasonably necessary. In other words, you cannot assert total control over the future actions of a seller, but you can restrict their actions to protect fundamental aspects of the business you are acquiring.

How to Enforce a Confidentiality Clause or a Non-Compete Clause

If a buyer thinks that a seller has breached a confidentiality clause, or a non-compete clause, they can apply to court to seek an injunction. The effect of the injunction is to stop the seller from continuing with their actions.

In practice, the legal action may result in the buyer receiving damages for the seller’s breach of contract.

Problems with enforcement

As you can see, enforcing these clauses can be difficult. Applying for an injunction can be time consuming and costly. Not to mention the problem that if the confidential information has already been shared, it may be too late to do anything about it.

It can also be difficult to calculate the level of damages that equates to a buyer’s loss resulting from the seller’s breach.

In many ways, it’s best to draft a clause that the seller is happy to comply with, rather than seeking to enforce draconian terms that they have no intention of complying with.

Practical Tips for Buyers

These clauses need to be reasonable, if they are to be enforceable. If you try to restrict a sellers’ actions too far, they may be inclined to ignore the clause completely or you run the risk of the clause being void and unenforceable. Neither outcome is one that should be considered.

Tips for drafting a reasonable confidentiality clause:

Properly define what constitutes confidential information.
Only seek to protect confidential information that addresses a legitimate business interest.
Expressly state what damage a breach could do to the business.

Tips for drafting a reasonable non-compete clause:

Limit the non-compete clause to a geographical location where the business trades.
State which customers or clients that the seller is not restrained from engaging with (usually this will be all of them but could be narrowed down in some circumstances).
Keep the limitations narrow and precise.

It’s always best to ask a specialist commercial lawyer to draft your asset or share purchase agreement for you, so that you can have confidence in their effectiveness and enforceability.

If you need advice, please get in touch.