Will a restraint of trade agreement survive the sale of a business?

by Larissa Holtzhausen on 11 June 2018
A recent decision of the Kwazulu-Natal High Court, Laser Junction (Pty) Ltd v Fick (2017), dealt with a particularly interesting issue regarding restraint of trade agreements, namely whether such agreements will survive the transfer of a business as a going concern.   

Restraint of trade agreements are generally contentious in the employment and contract law spheres, yet they are prevalent in the terms and conditions of employment contracts, and are, with a few exceptions, legally enforceable in South Africa. 

From the perspective of the employer, such agreements or clauses are often seen as necessary to protect the employer’s proprietary interests in their business from loss to competitors after the employer has invested knowledge of such interests in the training and development of an employee subsequently employed by a competitor. From the perspective of an employee, on the other hand, a restraint of trade may seem like an unjustified curb on the right to seek gainful employment. This is especially so when employees have specialised skill sets which limit the type of engagements available to them.  

In terms of section 197 of the Labour Relations Act (LRA), when a transfer of a business takes place, all employment contracts are transferrable to the new employer (the purchaser) by operation of law. ‘Transfer' in this sense refers to the transfer of a business by one employer to another employer as a going concern. This section is intended, according to the court in Laser Junction, to ensure that a transfer of business does not prejudice the employees and should be applied with this purpose in mind.  

In terms of the Act, when a transfer of a business takes place, the new employer will automatically be substituted in the place of the old employer in respect of all employment contracts in existence immediately before the date of transfer, and all the rights and obligations between the old employer and the employee at the time of the transfer will continue in force as if they had been rights and obligations entered into between the new employer and the employee. Essentially, the employees contract continues on the same terms with the new employer substituted as the other party to the agreement.  Importantly, the new employer must employ transferred employees “on terms and conditions that are on the whole not less favourable to the employees than those on which they were employed by the old employer”  in order to comply with the provisions of the Act.

What the court in Laser Junction deliberated was whether a restraint of trade undertaking would, in terms of s197 of the LRA, be thus transferrable, and remain valid notwithstanding the sale of business. 

The court interpreted the LRA as providing that only a contract of employment would be transferrable under section 197. It then turned to the definition of ‘employment contract’ under the Basic Conditions of Employment Act 75 of 1997 (BCEA) and held: “The BCEA stipulates that contracts of employment may contain the basic conditions of employment as provided in the BCEA or in a sectoral determination, and any law or term in a contract that is more favourable to the employee. The corollary of this, according to the court, is that a term which is less favourable than the BCEA to an employee cannot be a contract of employment”.  

The court therefore concluded that because a restraint of trade is not a term which is ‘more favourable to the employee’ (in fact it is manifestly unfavourable to the employee), it is not an employment contract and is therefore not automatically transferrable under the relevant section of the LRA.  

In coming to this conclusion, the court factored in the public policy considerations which inform the way in which competing interests should be reconciled when taking into account the interests of the parties and the public. The court also investigated whether the applicant had established a ‘protectable interest’ which the respondent had violated or threatened to violate. It was noted by the court that a restraint of trade is a severe limitation of several fundamental rights, including rights to freedom of trade, occupation and profession provided for in section 22 of the Constitution, and must be therefore be strictly construed.  It is further held that in order to withstand Constitutional scrutiny, a restraint agreement must be so vital to the protection of employer’s proprietary interests under s 25 and its rights to trade under s 22 of the Constitution that without it, its performance, commercial wellness and the livelihood of its workforce would be jeopardised. Additionally, no less restrictive means must exist to protect these rights and interests.  The court held that the restraint was not an employment contract, and it therefore had not survived the transfer and was not enforceable by the new employer. 

The court’s interpretation of the relevant legislation could have considerable and far-reaching consequences for employers and employees in future sales of business. Essentially, according to the judgement, no term in an employment contract which is ‘on the whole less favourable to the employee’ than the provisions of the BCEA will survive such a sale. This could potentially strike terms and conditions beyond restraints of trade and is therefore cause for concern. It would greatly impinge upon legal certainty if, upon a sale of business, each term of an employment contract had to be measured and validated against the arguably vague standard of its being ‘more or less favourable to the employee’ in order to survive the transfer.   

It must be noted that the Hight Court, in coming to its decision, failed to consider a prior judgement of the Constitutional Court on the same issue, and the status of the judgement as binding precedent is therefore open to question. The Constitutional Courts’ interpretation of the same provision of the LRA in Horn v Health Medical Scheme 2015 (7) BCLR 780 (CC) allowed for a restraint of trade to be transferred to a new employer upon a sale of business as the LRA expressly provides for the transfer of ‘all rights and obligations’. 

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Please note that the legal topics informally discussed here are general discussions of certain aspects and therefore certainly not intended as legal advice.  We look forward to discussing your particular case with you.

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