What happens if you breach the restraint of trade clause in a sale contract

When a real estate agency or rent roll changes hands, one clause to be aware of is restraint of trade. 

This clause exists to protect the buyer’s investment. If a vendor ignores the fine print, the fallout can be serious for everyone.

What is a restraint of trade clause?

A restraint of trade clause is a contractual agreement limiting the activities the vendor of a business can undertake after the sale, particularly when operating in the same industry or geographical area. 

The clause typically prevents the vendor from setting up or working in a competing agency, engaging former clients or staff or otherwise interfering with the goodwill sold as part of the transaction. The purpose is to protect the buyer’s ability to benefit from their purchase without immediate competition from someone who knows the business and the area.

A typical restraint of trade clause lasts between three and five years and will prevent the vendor from directly competing with the buyer’s business.

‘Competing’ includes launching a new agency in the same area, working directly for a competitor, or quietly picking up PUMs on the side. In other words, the vendor can’t ‘fish in the same pond’.

These clauses are particularly important if a rent roll is part of or all of the transaction because the buyer is paying for goodwill, reputation and income as well as a list of properties to manage. If the vendor continues to operate or launches a rival business, it puts the buyer’s assets and earning potential at risk.

Learning the hard way

BDH Valuers was recently engaged to value a real estate business where the vendor agreed to a full sale of their rent roll, then proceeded to ignore the restraint terms entirely. Instead of selling and moving on, the vendor kept their business open and is now in direct competition with the purchaser. As a result, the matter is heading to court.

The purchaser’s position is clear: if they had known the vendor would continue trading, they wouldn’t have gone through with the deal. They bought the business under the assumption that the vendor would honour the agreement and close the doors on their business, giving the purchaser room to carry on and grow.

Breaches like this fundamentally alter the value of the business. The original valuation was based on the assumption, the vendor would no longer be in the market. With the restraint of trade clause broken, the buyer has every right to lose confidence and request a revaluation.

From a legal perspective, restraint of trade clauses are enforceable if they’re reasonable in relation to time and geographic scope. In court, they will generally be backed if they have been clearly negotiated and are proportionate to the type of business being sold. 

In real estate, where personal relationships and reputation drive so much of the value, restraint clauses are essential. Yet despite their importance, some sellers still make a costly mistake by treating them as optional. 

When you sell your real estate business or rent roll, the message is simple: if you agree to a restraint of trade, you need to step aside - for real. This means no ‘backdoor’ deals, no client/staff poaching and no re-entry into the same market under another brand name. 

Breaking the agreement and the resulting legal action can force you to return the money you were paid for the rent roll and leave everyone back at square one.

If you’re a buyer, don’t rush through the restraint of trade part of your contract. Take the time to review the details with your lawyer and ensure your interests are protected, so you don’t wind up going backwards or dealing with a trip to court. 

Need help understanding the true value of a rent roll you're planning to buy or sell? Reach out to BDH Valuers today.