What does restrictive covenant mean?
What are the different types of covenants?
What are some examples of restrictive covenants affecting us all?
How are restrictive covenants used in real estate transactions and business?
In this article, we will break down the notion of a restrictive covenant so you know all there is to know about it.
We will provide you with the definition, discuss how they can be enforced, possible limitations and go over examples in real estate, employment relations, insurance and business in general.
Are you ready?
Let’s get started!
Table of Contents
What is a restrictive covenant?
A restrictive covenant is a commitment given by one contractual party to the other to do or not to do something.
A “covenant” is like a “promise” and a “restrictive covenant” is likee a “contractual condition”.
Restrictive covenants can relate to any action mutually agreed to by the contracting parties or any restrictions imposed by law.
To understand what are restrictive covenants, think about it as a promise that you will do something in the future or you will not do something in the future.
The person making the promise is the covenantor and the person who receives the promise is the covenantee.
For example, if you rent a car and the contract states that you must maintain the car in the same conditions as the day you took delivery, that’s a restrictive covenant.
You promise that you will take the car and return it in the same condition without scratches or damages.
Restrictive covenant definition
According to the Merriam-Webster dictionary, a restrictive covenant is defined as follows:
“a covenant acknowledged in a deed or lease that restricts the free use or occupancy of property (as by forbidding commercial use or types of structures)”
According to Nolo’s Plain-English Law Dictionary, a restrictive covenant is:
“An agreement (covenant) in a deed to real estate that restricts future use of the property.”
What we can take from these definitions is that restrictive covenant means an agreement between contracting parties imposing some restrictions for the future.
Restrictive covenant agreement
A restrictive covenant agreement is an agreement entered into between two parties or more whereby the action of a party is restricted in the future or an affirmative obligation is imposed on a party.
Although a restrictive covenant agreement can be a standalone agreement, most often restrictive covenant obligations are incorporated in a different type of agreement.
For example, the purchase of a real estate property will most certainly include restrictive covenant clauses.
M&A transactions will include restrictive covenants imposing limitations on the parties’ behaviour and actions in the future.
Limiting restrictive covenants
Is there a way that you can limit restrictive covenants?
The answer is, it depends.
In many cases, restrictive covenants have an important objective and a legitimate purpose.
They may be contractual or legally imposed.
If the covenant is legally imposed, the parties cannot limit it in any way in a contract.
For example, a non-compete provision is unenforceable in California.
As a result, even if an employee were to sign a non-compete restrictive covenant and violate the non-compete agreement, the employer is limited in how it can enforce such a covenant on its employees.
If the restrictive covenants have been contractually imposed, you can speak with the other contracting party and mutually agree on limiting the scope or timeline of the covenants.
For example, if a homeowner association imposes a restrictive covenant prohibiting homeowners from renting their property for terms of less than 6 months, the objective is to guarantee a certain level of peaceful enjoyment to the other homeowners in the vicinity.
In some cases, you may have signed a restrictive covenant but believe that you have been tricked into signing such a covenant.
If you have reasons to believe that you signed a contract with severe restrictive covenants based on misrepresentation or fraud, you may file a lawsuit to void the contract.
You may ask the court to either cancel the contract if the covenants have materially affected the consideration you expected in the contract or limit the scope of the covenant.
Breaching restrictive covenants
Restrictive covenants are restrictions imposed on the future use of a product or actions of a person or entity.
Breaching restrictive covenants will generally result in the levy of penalties against the breaching party.
For example, if John rents a car with a restrictive covenant that the car should not be damaged or scratched, then John will be imposed a penalty or a fee for breaching that covenant if indeed he does scratch the car.
In some cases, the breach of a restrictive covenant can lead to a material breach of contract.
For example, if a business signed a partnership agreement with another company based on the covenant that they do not develop a competing product and they end up doing the same, that’s a material breach of contract.
Depending on the nature of the restrictive covenant and the importance of the consideration for a party, violating the restrictive covenants can lead to a minor violation or material violation of the contract along with a risk of a lawsuit.
Enforceability of restrictive covenants
The enforcement of restrictive covenants will depend on several variables such as:
- Reasonableness of the restrictions imposed
- Bargaining power of the parties
- Application of restrictive covenants based on local laws
Depending on your jurisdiction and the applicable laws, you may have other variables.
We are referring to general ones for the same of our discussion.
Reasonableness test
Unless the law imposes specific requirements relating to the enforcement of restrictive covenants, the enforceability of restrictive covenants will generally need to pass the “reasonableness” test.
Is a contractual party imposing a reasonable restrictive covenant on the other to protect a legitimate interest?
For example, if an employer imposes non-compete covenants on a former employee barring the person from the entire industry, on a worldwide scale and for the next 10 years, that will surely not pass the reasonable test.
The objective of the non-competition restrictive covenant is to prevent abuse by a former employee and to protect a company’s legitimate interest but not to prevent a person from earning a living.
In an employment contract, to decide if restrictive covenants should be enforced or not, the courts will need to look at the overall facts of the case and determine if the terms of the restrictive covenants are not excessive, does not impose an undue hardship on the employee and does not violate public policy.
Enforcing party
To enforce a restrictive covenant, the non-breaching party can legally enforce the covenants in court.
In a private contract or relationship, the non-breaching party will need to enforce the contractual covenants against the breaching party by filing a lawsuit.
If the consequence of a breach of the covenant is the imposition of a penalty, the non-breaching party will ask for monetary damages.
If the monetary aspect is not important but the conduct, actions and behaviour of the breaching party are relevant, a request for injunctive relief can be filed to either prohibit someone from doing something or compel them to do something.
If the breach of the covenants results from the violation of a law or statute, the enforcing party may be the state or government.
For example, if a person is conducting a business out of a residential property, the state may enforce the restrictive covenants against the property owner for violating zoning laws.
Restrictive covenant employment
In employment relationships, there are different types of restrictive covenants.
Many employers attempt to impose covenants on former employees to restrict them from competing against them or using their trade secrets.
Let’s look at a few common types of restrictive covenant prevalent in employment contracts.
Non-competition restrictive covenant
The non-competition restrictive covenant is a condition imposed by an employer on a former employee preventing the person from competing against the employer’s business.
Typically, the non-competition covenant is limited in time, geography and scope.
Non-solicitation restrictive covenant
Another type of restrictive covenant found in employment agreements relates to the non-solicitation of the employer’s clients and prospects.
A non-solicitation undertaking is one where the former employee commits not to solicit, entice or lure his or her former employer’s clients, customers and prospects.
Generally, the non-solicitation covenant is limited in time.
“Anti-raiding” restrictive covenant
An “anti-raiding” provision is a form of restrictive covenant imposed on former employees preventing them from soliciting other former employees to compete against their previous employer.
This type of clause is to prevent a competitor from hiring a former employee of a competing organization and having that person reach out to other former employees to hire them for competitive purposes.
Confidentiality restrictive covenant
Another common type of employe-related restrictive covenant is an employer requiring its employees and former employees to keep the information they obtain on the job as confidential.
This restrictive covenant imposes a restriction on the employee from disclosing the employer’s confidential information.
This can also be found in non-disclosure agreements or NDA’s.
Restrictive covenant real estate
You will find restrictive covenants in a deed of sale relating to a real estate transaction.
Restrictive covenants in real estate are sometimes referred to as “deed restrictions”.
It’s important to understand what restrictions are imposed on the use and ownership of a property before purchasing one.
In many cases, buyers may not pay attention to the restrictive covenants they signed in a deed of purchase and end up with a surprise after the fact.
In real estate, there are typically two types of covenants:
- Restrictions on use of a property
- Affirmative obligations on the property owner
For example, a restriction on the free use of the land is a restriction or limitation of use.
An obligation imposed on the property owner can be for example the payment of condo fees or owners association fees.
This obligation does not limit a person’s use of the property but imposes an obligation to pay certain dues.
Let’s look at a few common restrictive covenants found in a deed or leased property.
Restrictive covenant on the use of property
In nearly all real estate properties, you will have some sort of restriction or limitation on the use of the property.
For example, a residential property cannot be used for commercial purposes.
That’s a restrictive covenant all residential homeowners will need to respect.
A commercial real estate property may have limitations on the type of business that can be operated using that property.
Restrictive covenants on the use of a property can be found in your title deed or statutory.
Architectural restrictive covenants
In some real estate transactions, you may have restrictive covenants relating to architectural guidelines.
In other words, the buyer must observe certain architectural requirements in the future.
For example, certain properties are considered historical properties and the facade of the property cannot be demolished.
As a result, a buyer of the property will be restricted, through a property covenant, from demolishing or altering the property facade.
Another example of an architectural restriction is when property owners in a certain neighbourhood are required to respect the architectural requirements for that area such as exterior colour, type of material used or even the type of roofing used.
Construction restrictive covenants
The law or your title deed may impose restrictions on what can be built on your land and where.
For example, you may have restrictive covenants prohibiting the installation of a fence.
Perhaps, you may be restricted to install a swimming pool or build anything within 40 feet of the perimeter of your land.
These construction limitations can be imposed by the zoning laws, your deed or other rules and regulations.
Restrictive covenant mortgage
Most homeowners are familiar with a mortgage.
When you ask a bank to finance the purchase of your house, you’ll need to grant the bank a mortgage on your property to secure their loan.
The mortgage comes with different kinds of restrictive covenants.
In a deed of mortgage, you may see:
- Covenants requiring you to maintain adequate insurance on the property
- Covenants to pay your mortgage payments by a certain date
- Covenants preventing you from changing the destination or use of the property
Depending on the nature of the property purchased and who is asking for a mortgage (individual or company), the covenants may be different.
For example, a company borrowing money may have restrictive covenants to meet certain financial liquidity ratios or certain debt/equity ratios to remain eligible for a line of credit or financing.
Leasing restrictive covenants
Some properties can be leased while others cannot.
In some homeowner association rules, there are restrictions to the effect that a condo cannot be leased to a tenant for short-term periods.
This is to prevent disruptions caused to other homeowners by someone renting their property for a few days or a few weeks at a time to travellers and people on vacation.
A leasing restrictive covenant can require that the term of a lease cannot be less than 6 months or 12 months to comply with the property covenants.
Restrictive covenant examples
There are countless restrictive covenants examples out there.
You have probably signed restrictive covenants multiple times in your life without thinking about it.
Let’s look at some of the most common examples of restrictive covenants.
Restrictive covenant insurance
Insurance companies are notorious for imposing restrictive covenants or conditions of use on goods for the insured to remain insurable.
For example, an insurance company will impose covenants on property owners to ensure that their property is always kept supervised and not abandoned to benefit from the fire insurance or get protection against theft.
If the property owner goes on vacation for one month without having the property supervised and suffers damages due to theft, the insurance provider may argue that the policy covenants were not obeyed leading to no coverage for the theft.
Restrictive covenants in a lease
In a lease agreement, the landlord may require that the tenant adequately maintain the property and refrains from performing any renovations or leasehold improvements without obtaining the landlord’s prior approval.
In this example, the tenant is subject to a restrictive covenant to do something and not to do something.
First, the tenant must take the proper actions in the future to maintain the property.
Second, the tenant must refrain from doing any renovations or leasehold improvements without getting prior approval.
Restrictive covenants in business
Restrictive covenants are very common in business.
They are generally legal and enforceable in court.
For example, a company may impose restrictive covenants on a user of a product or a good so they can benefit from free support services or certain warranty.
If the user of the good does not respect the covenants of usage, they may void their warranty or have to pay additional fees.
In mergers and acquisitions or M&A transactions, we see restrictive covenants used quite a bit.
Generally, the acquiring company will impose on the target company’s executives and key personnel who are subject to the acquisition non-compete provisions restricting their ability to compete within a certain timeframe following the acquisition of the target.
Also, one main priority for businesses is the protection of their trade secrets.
As such, companies require their employees, partners, suppliers, vendors and clients to enter into non-disclosure agreements protecting the company’s trade secret and disclosure of confidential information.
Takeaways
Restrictive covenants are very common in our daily lives and in the business world.
If you own a home, you’ve probably signed various restrictive covenant provisions in your deed of purchase.
If you are in business, you may have signed many restrictive covenants relating to how you can use a product in the future.
Restrictive covenants are legal and generally enforceable unless they violate the law, public policy or do not meet the reasonableness test.
Before agreeing to restrictive covenants, be sure to read and understand the consequences of what is requested to ensure there are no surprises.
