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A restrictive interpretation?

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2nd March 2021

Andrew Butler QC assesses the recent Court of Appeal decision in Quantum Actuarial LLP v Quantum Advisory Ltd [2021] EWCA Civ 227, in which he appeared for the Appellant. The case concerned covenants in restraint of trade, arising in an unusual context.

Introduction – the Legal Landscape

Covenants in restraint of trade present, in the words of the editors of Chitty on Contracts, “peculiar conceptual difficulty”. It is well known that such covenants may attract the application of the Nordenfelt test – namely, they must be no wider than is reasonable by reference to the interests of the parties concerned and the interests of the public. However, not every covenant in restraint of trade engages that test. Which do and which do not is a question which, as many judges have acknowledged, defies a precise or exhaustive answer.

Traditionally, in deciding whether or not a covenant engages the Nordenfelt test, the Courts have applied the “pre-existing freedom” test. This test, which emanates from the majority speeches in the House of Lords in Esso Petroleum Ltd v Harper’s Garage Southport Ltd [1966] 1 WLR 1234, focusses on whether, in entering the covenant, the covenantor was giving up a pre-existing freedom. If, prior to giving the covenant, it was entirely free to trade as it wished, it would be doing so, and the doctrine would apply. But if the covenants were contained in the very transaction which gave the covenantor the opportunity to trade – for example, a lease or purchase of a particular piece of land – it would not be. In the latter case, the doctrine would not apply. The covenant would just be regarded as one of the terms of the deal.

In Esso, however, Lord Wilberforce articulated a different test. According to this test, whether the doctrine applies depends on whether the agreement was one of a kind which “had passed into the accepted or normal currency of commercial or contractual or conveyancing relations”. If it had, the Nordenfelt test would not apply. This test has become known as “the trading society test”.

In Peninsula Securities Ltd v Dunnes Stores Ltd [2020] UKSC 36 – which was decided after the trial in Quantum, but before the appeal – the Supreme Court rejected the “pre-existing freedom test” in favour of the “trading society” test.

The Quantum Case

In Quantum, the doctrine fell to be applied in an unusual set of circumstances. In 2007, Quantum Advisory Ltd (hereafter, “Quad”), along with two other companies with some common ownership, wanted to restructure its business. Quantum Actuarial LLP (“LLP”) was incorporated as a vehicle for providing the services which Quad had historically provided, and a Services Agreement (“the SA”) was entered. Under the terms of the SA, LLP would provide the services; Quad would invoice the clients, and would then retain 43% of fees while distributing 57% of fees to LLP. This split was intended to give Quad the profit from those clients, while meaning that LLP would cover its costs. The benefit for LLP was that it would obtain a foothold in the market and would otherwise be free to develop its business as it wished.

The SA contained covenants preventing LLP from engaging directly with the clients for the term of the agreement and for one year beyond (“Clause 2.2”). LLP had very limited rights of termination and could not assign or novate the SA.

The SA was the product of discussions between three colleagues in Quad – B, C and R. Of these three, only R had any financial interest in LLP. Quad’s lawyer was also involved, and indeed had drafted the SA, but LLP had no separate legal representation. The SA was originally intended to endure for a term of 10 years. However, late in the negotiation, concern was expressed by R as to what would happen to the clients on termination. It was decided to simply sidestep this difficulty by extending the period of the SA to 99 years. But the other terms, and in particular Clause 2.2, remained unchanged.

As time went by, and personnel in LLP changed, resentment grew at the fact that it was required to undertake Quad’s work at cost – and furthermore, would be required to do so for at least a further 88 years. In July 2018, LLP wrote to Quad stating that it regarded Clause 2.2 as containing unreasonable restraints of trade and declaring that it would, with effect from September 2018, regard them as unenforceable. In response, Quad commenced the present proceedings seeking declaratory relief as to the enforceability of the SA. At first instance, the Judge (HHJ Keyser QC sitting as a Judge of the High Court) upheld Quad’s case. LLP appealed to the Court of Appeal (“the CA”). As stated above, by the time the appeal was heard, the Supreme Court had delivered its judgment in Peninsula.

LLP’s submissions to the CA

Before the CA, LLP submitted that the pre-existing freedom test had fallen away, and that the SA was sufficiently unusual that it failed the “trading society” test. Even if that would not otherwise have been the case, LLP said, the exceptional duration of the SA made it so. Further, it submitted that in the formation of the SA there had been an imbalance of bargaining power. This emanated not, as in some cases, from the relative experience of the parties, but from the fact that everyone concerned with the formation of the SA had a financial interest in Quad, only one had any financial interest in LLP, and furthermore LLP had had no legal advice. It further submitted that Quad had no legitimate interest which could sensibly be protected for a century, and that this absence of legitimate interest, together with the breadth of Clause 2.2, rendered it unreasonable.

The CA’s Decision

The CA (Moylan, Stuart-Smith and Carr LJJ) rejected these submissions. As regards the appropriate test, it decided that the trading society test could not be of universal application. Otherwise, it said, an entirely novel kind of contract would always attract the application of the Nordenfelt test, and that would be a “most surprising result”. The SA fell to be considered on its own terms. It was however within the ambit of one type of contract identified by Lord Wilberforce in Esso as satisfying the trading society test – namely, where a vendor sells a business and covenants not to compete. Here, LLP was carrying out the business, but not acquiring it. The situation was “the mirror reverse” of the vendor-purchaser situation.

On the imbalance of bargaining power, it held that the SA was the product of discussion between experienced businesspeople. While the change to the 99-year term was clearly a “very significant alteration”, the Judge made no finding that no-one concerned with LLP had considered the effect of Clause 2.2 in the changed environment of a 99-year term. Many weeks had passed between the making of the change and the signing of the SA, and no pressure was placed upon LLP to conclude it.

Having regard also to the commercial background to the SA, the fact that Clause 2.2 was fairly and properly ancillary to it, and the existence of other provisions in the SA supporting its enforcement (such as a contractual acknowledgement that it was fair and reasonable as between the parties), the CA concluded that the Judge had been right to say that Clause 2.2 did not engage the Nordenfelt doctrine, and furthermore that if it did, it was reasonable. Accordingly, it dismissed the appeal.

Conclusion

While the CA held that the trading society test could not be of universal application, it is notable that its judgment does not identify an alternative test which is to be applied in circumstances where the trading society test is inapposite. It remains to be seen whether this omission will open the way for a further appeal to the Supreme Court.

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