General principles of contracts series; (part 8) Legal possibility (continued)

In the previous instalment of the series, we looked at one of two factors that might render a contract legally impossible; being illegality in the pure sense. And now we will take a look at Public Policy.

Public Policy

As we have seen, a contractual undertaking to perform an act that is not necessarily illegal in the pure sense, but is contrary to public policy (or even immoral), might also be void. This scenario would apply where there is no law specifically preventing the terms described in the contract, but the terms are, in the eyes of society, still wrong. (You may be aware of the term "contra bonos mores" - this has the same meaning as "against public policy"). Unlike illegality, public policy and immorality are not clear-cut concepts, and are usually subject to great debate (which society ever completely agrees on what behaviour is "wrong" or "right"?) This means that the issue of contracts that might be void due to public policy could be a controversial one, depending on what contractual terms we're talking about.

The most vital aspect of public policy - restraints of trade

A restraint of trade is an undertaking by one of the contracting parties to refrain from working in a particular industry, in a particular area, for a particular time. These contracts are often entered into by new employees at companies which seek to restrain them from later applying what they have learned in other, competing, companies. They are also very common in sales of businesses where the buyer seeks to restrain the seller from opening up a nearby competing business once the seller has been paid and has moved on.

Restraints of Trade are also very common in the music industry, where record companies often seek to restrain artists from recording with competing companies once their tenure with that company is completed. Managers often put them in artist management agreements, believing that they have "made" their artists, and therefore have the right to restrict them from signing to any other management company for a time after their management contracts come to an end.

Publishers have often been known to insert restraints of trade in composer's publishing agreements, believing that once they have placed their writer's music on the map, the writers should be restrained from working with any other publishers for a period of time after their writers' contracts expire. Restraints of trade are found in employment agreements with sound hire companies, recording studios and production houses. They are common clauses in contracts for the sale of music businesses, where client lists and creative reputation are vital. Restraints of trade, then, are to be found everywhere, and especially in the music business. We need to have an understanding of them.

Here are some examples of restraints of trade:

1. An artist signing to a record company agrees not to record for any other record company during the term of the agreement and for a period of three years after termination of the contract; 2. An artist signing to a music publisher agrees not to be published by any other South African publishing house for five years after termination of the agreement; 3. A music producer selling his studio agrees not to open another studio within a 200 km radius of the studio he is selling, for a period of five years after the sale is concluded; 4. A new vocalist joining a successful band agrees not to sing for any other South African band for two years after he leaves the band; 5. A budding sound engineer, looking for employment at a sound hire company, agrees not to work for any other sound-hire company for a period of three years after termination of his employment agreement (to protect the company from losing its client base and mixing secrets, which he will learn while he is employed there); 6. A well-known talent manager only signs artists that agree, in their management contracts, not to sign to any other South African talent manager, for five years after termination of the management agreement; 7. A radio station hiring a new DJ makes him sign a restraint of trade so that the station's listenership is protected should the DJ later decide to leave to join another station.

The Controversy

So why are we looking at restraints of trade under the heading of "Public Policy"? Well, restraints of trade are something of a controversial issue, and there are two distinct legal views on them: the first view is the "pacta sunt servanda" rule ("contracts are binding") which holds that a promise made should be kept, and therefore restraints of trade, controversial or not, should be binding. The second view is the "Public policy" view which holds that a contract that seeks to prevent a person from working honestly and earning a living is against the public policy of our society, and therefore that restraints of trade should be void (i.e. any person is entitled to engage in useful economic activity and in so doing will contribute to the welfare of society by the exercise of these skills).

But unfortunately, the law in this field is a little more complex than simply holding the contract to be binding or void. A more subtle approach is taken, that being the principle of "burden of proof." (The burden of proof is literally the onus to prove or disprove something on a balance of probabilities by leading evidence).

(Please note that when we talk about restraints of trade, we call the parties "covenantor" and "covenantee." The covenantor is the person making the promise not to work, i.e. the employee, the seller of the business, the artist or the composer. The covenantee is the employer, the buyer of the business, the record company, the manager or the publisher).

Those who take the "public policy" approach to restraints of trade propose that, for the restraint not to be binding, the covenantor must prove on a balance of probabilities that the restraint of trade is contrary to public policy and therefore void. Those who take the "pacta sunt servanda" approach would rather propose that the covenantee must prove on a balance of probabilities that the restraint of trade is not contrary to public policy and therefore valid. The debate therefore relates to the burden of proof.

For many decades, the debate raged in our courts, with some provinces taking the first view and others the second until finally, in 1984, the matter was (largely) settled by our highest court, the appellate Division, now called the Supreme Court of Appeal. (I say 'largely' because despite the precedent being set by the Appellate Division rulings).

Although it is a lot more complex than this, for our purposes, a simple explanation of the current state of South African law on this issue, as per the Appellate Division, is this: restraints of trade are prima facie binding until proven by the covenantor to be contrary to public policy (i.e. the "public policy" approach to the burden of proof applies). ("Prima facie" means to begin with, until the contrary is proven. And for our purposes, proof that a restraint is against public policy would be the same as proof that the restraint is unreasonable in the circumstances).

The factors that are taken into account by a court in deciding whether the covenantor has proven the restraint to be contrary to public policy/unreasonable are as follows:

1. Nature of the restraint: (i.e. is it just there to prevent competition and prevent the covenantor from using his skills elsewhere, or does it legitimately protect a genuine asset of the covenantee's?);

2. Area of the restraint: (i.e. the territory covered by the restraint should not unreasonably exceed that area of business which is sought to be protected. We should remember, in this respect, that the music industry is becoming more global by the day);

3. Time period of the restraint: (i.e. bearing in mind the industry in which the parties operate, what is a reasonable time for the covenantee's interests to be protected?);

4. Bargaining power of the parties at the time of entering into restraint: (for example, the court will take into account that a major record company has far more bargaining power than a young, struggling musician looking for his first break);

5. Protection of the covenantor's subjective personal talent and knowledge as opposed to the covenantee's trade secrets: (to the extent that the covenantee may have an asset or interest deserving of protection, can it be proven by the covenantor that this asset or interest is qualitatively and quantitatively outweighed by the interests of the covenantor?

That is, will the restraint unreasonably prevent him from using his own subjective personal talent (not skills created or groomed by the covenantee) and render him economically inactive?

6. As you can see, the covenantor has a lot to do in court to discharge his burden of proof in proving that the restraint is unreasonable. That's the problem - until he does this hard and expensive thing, the restraint is binding on him. Only once the court has heard the evidence relating to these factors, will it then decide whether the covenantor has discharged his burden of proof and proven that the restraint is unreasonable/against public policy and should therefore be held void. If he has done so, great - he can go back to work if he hasn't by now had a nervous breakdown or gone bankrupt in the process. If he has not done so, the nervous breakdown and bankruptcy will be followed by the news that the restraint against him will be upheld.

Regarding employer/employee restraints designed to protect the employer's trade secrets, these restraints, like all others, are prima facie enforceable until proven contrary to public policy. But our senior courts, since 2006, are beginning to insist that these particular restraints are drafted in a far more specific manner than in the past, including showing the employer's protectable interests, failing which they will be more easily rejected and held to be against public policy if brought to court.

Please also note that a 2007 Constitutional Court case held that public policy in contracts is a constitutional issue, and a 2008 Cape High Court case relied on this to hold that restraints of trade that are too broad should be rejected in weighing up pacta sunt servanda with the public policy that people should be productive in their chosen work in the interests of society - the "dignity of work." So the scales may be starting to tip the other way again , at least in the Cape, but this will take a long time, if it does happen.

So restraints of trade are, in South African law at least, pretty bad news for the covenantor. How about in the rest of the world?

In the UK, the public policy approach applies to restraints of trade, i.e. the covenantee has to prove that the restraint is reasonable and not contrary to public policy for the restraint to be binding. In the US, restraint of trade is largely an anti-trust issue, with many states following California law. The onus is on the covenantee, as in the UK. (In addition, there is a seven-year limit on restraints and contractual terms generally, in California. Many, but not all, states follow suit).

Radio DJ. Young man with microphone and headphone.

Restraints of Trade in the South African radio industry

It is common practice for South African radio stations to insert restraint of trade clauses into employment contracts of DJ's due to the fact that DJ's, it is generally thought, have personal fan-bases that follow them from station to station. While most South African stations continue to do this, YFM made the announcement in March 2008 that it would drop this common radio industry practice, and that all new contracts signed by YFM going forward would no longer bind presenters to being off-air for a period, once their stint with the station is concluded.

YFM's reasoning, it said, is that the practice of restraints for deejays is outmoded, anticompetitive, and based on a misconception that the presenter is bigger than the brand.

"Broadcasters have had this crazy idea that when dj's leave a radio station, they will take their audience with them. Our experience is that this is not the case. In spite of having said goodbye to some of the big names in broadcasting a year ago, we have grown our audience share year on year." Most other radio stations have not followed suit.