Restraint of Trade Clauses: Drafting, Enforcing and Litigating

Restraint of Trade: Valid or Void?

Which of the following interests take precedence in the context of an employer seeking to restrain a former employee?

  1. The interests of an employee in being able to earn a living by using his or her legitimately obtained skills, experience and knowledge;
  2. The interests of the public in being able to obtain the services of an employee, the freedom of trade and the freedom to engage in competition; or
  3. The employer’s interest in protecting confidential information, customer connections, staff and supplier connections, which the employer has spent much time, resources and money to develop.

This is a question with no particular answer.

At law, the interest of the public takes precedence, making restraints of trade in employment contracts void.

However, courts are now more willing to enforce restraint of trade clauses if the employer is able to demonstrate that the restraint is reasonably necessary to protect the employer’s legitimate business interests, and is not so large as to interfere with the interests of the public (Nordenfelt v Maxim Nordenfelt Guns and Ammunition Company [1894] ACC 535 at 549; Lindner v Murdock’s Garage (1950) 83 CLR 628).

Legitimate Business Interests

Employers must first be able to identify a particular business interest that is legitimately protectable. It is not enough to simply seek to stop former employees from becoming employees of a competing business (Stenhouse Australia v Phillips [1974] AC 391).

Generally, the following business interests have been identified by courts:

Confidential Information

Note that the mere fact that a former employee had access to confidential information is not, in of itself, sufficient to justify a restraint.

The enforceability of the restraint of trade clause falls for consideration having regard to the nature of the confidential information, the duties performed by the employee and his or her position overall in the organisation (Sportsbet Pty Ltd v Carpanini & Anor [2014] VSC 166 at [28]).

Customer Connections

This will be protectable where the employee in question controls the employer’s customer connections and where the nature of the work is heavily reliant on client relationships (Pearson v HRX Holdings Pty Ltd [2012] FCAFC 111. See also Wallis Nominees (Computing) Pty Ltd v Pickett [2013] VSCA 24 where it was held that the obligations of an employee under the non-solicitation provisions of a restraint clause are dependent on two factors: “First, that an employee must be in a position to gain trust and confidence so as to be relied on in a client’s affairs. Secondly, that the relationship between employee and client is such that there is a possibility that if the employee leaves the business of the employer he or she may carry away the client’s business with them.”).

The risk of solicitation of customers occurring is generally high in accounting, legal, and broker firms. This is because “[the employee] has the opportunity – and the obligation – to develop a personal relationship with [the client] and to acquire knowledge and understanding of the client’s affairs.

Those are the very things which are likely to make it attractive to the client to leave [the employer] when the employee leaves, in order to be able to maintain that relationship and take advantage of that accumulated knowledge and understanding.” (Birdanco Nominees Pty Ltd v Money [2012] VSCA 64).

Stable Workforce

This is a more recent development.

The more recent cases have tended to support restraints against former employees from poaching other employees of the employer on the basis of protection of confidential information where the former employee may seek to exploit knowledge gained of the particular qualifications, rates of remuneration, and so on, pertaining to other employees (confidential to the employer) (See Dawnay Day & Co Ltd v De Braconier D’Alphen [1997] IRLR 442 at [45]–[46]; Aussie Home Loans v X Services [2005] NSWSC 285 at [24]–[26]; Kearney v Crepaldi [2006] NSWSC 23 at [58]).

The court in Cactus Imaging Pty Limited v Glenn Peters [2006] NSWSC 717 at [55] asked itself the question:

But apart from protection against misuse of confidential information, does an employer have a protectable interest in staff connection — that is, in maintaining a stable trained workforce?

The cases denying that there is any such legitimate interest emphasise that an employer does not own the workforce, as if employees were akin to stock-in-trade. That is self-evident, but nor does an employer own the customers, who are also not akin to stock-in-trade; yet a connection with customers is unquestionably amenable to protection by covenant.

The employees, along with the suppliers and the customers, make up the three relations upon which the profitability of a business depends.

The customers are not property, but their connection with the business adds value to the business and is recognised as deserving of protection in the proprietor’s legitimate interest.

Similarly, employees are not property, but, all else being equal, a business with a stable trained workforce will be more attractive to a purchaser and command a higher price than one with a workforce which is unstable, disruptive or poorly trained, just as a loyal and satisfied clientele makes a business more attractive and valuable.

In my opinion, staff connection constitutes part of the intangible benefits, which may give a business value over and above the value of the assets employed in it, and thus comprises part of its goodwill. It is amenable to protection by a covenant in a manner similar to customer connection, even in the absence of protectable confidences.

For a business interest to be protectable in the circumstances, the employer must be able to demonstrate that it will suffer real harm to the protectable interest if the employee is not restrained.

Once a business interest has been identified and is considered legitimately protectable, the drafter must consider what is reasonably necessary to protect this interest.

Restraint of Trade Must Be Reasonably Necessary

The restraint must be reasonable in all circumstances and reasonableness is to be assessed as at the time the employment agreement was entered into. Therefore, it is imperative to ensure that when drafting a restraint of trade you carefully consider:

  1. The particular business interest;
  2. Whether this business interest is legitimate and therefore protectable;
  3. What is reasonably necessary to protect this legitimate business interest having regard to the particular circumstances of the case including the employee’s position, and what scope, distance, length of time, geographic area is necessary to reasonably protect that interest. Generally, the more experienced, senior and tenured the employee, the more extensive the restraint that may be enforced against them (OAMPS Insurance Brokers Limited [2010] NSWCA 267).

Note also the relevance of the date when the agreement was entered into, and that new contracts should therefore be signed at each change in role. There is the problem of a more junior appointment morphing into a senior role, but on the same terms and conditions.

Often drafters fail to carefully consider the last of those questions and often fall into the trap of thinking that drafting a very wide provision will protect the employer’s interest. However, overreaching often means destroying any chance of protection.

Overreaching and Destroying

Even if an employer is seeking to protect a legitimate business interest, overreaching is likely to mean the provision will be declared void.

For example, in the case of Sportsbet Pty Ltd v Carpanini & Anor [2014] VSC 166, Sportsbet sought to restrain a former Client Services Manager, Ms Carpanini, from providing services to, participating in, being interested in, assisting with or otherwise being directly or indirectly involved in, engaging in, being concerned or interested in a Restricted Business in the Geographical Area, in any capacity for a period of 6 months after termination of employment.

The restraint:

  • Sought to protect Confidential Information as being the legitimate business interest;
  • Defined the Geographical Area as being Australia;
  • Defined the Restricted Business as “any business that competes with or is likely to compete with the business of the Beneficiaries”.

The court would not order an interlocutory injunction, holding that it was strongly arguable that the restraint was too wide to be enforceable. The clause essentially meant “she could not take a job as a cleaner with a competitor, for instance. Likewise, she would be prevented from even buying shares in a competitor such as Tabcorp.” (Sportsbet Pty Ltd v Carpanini & Anor [2014] VSC 166 at [29]).

The court also referred to a New South Wales Supreme Court case, TV Shopping v Scutt (1998) 43 IPE 451, which held that “the words ‘in any capacity’ must destroy a restraint as being unreasonable…the fact that a covenant was expressed too widely would destroy the whole covenant, even though what the defendant was doing was clearly something which could have been prohibited had the rights words been used.” (Sportsbet Pty Ltd v Carpanini & Anor [2014] VSC 166 at [30]).

In relation to each element of a restraint, one must ask himself/herself, “is this really necessary?”

For example:

  • Is it really necessary to prevent the employee from working in any capacity with a competitor? (scope of position). If not, what “capacity” are you seeking to prevent.
  • Is it really necessary to prevent the employee from working with any business that competes with or is likely to compete with the employer’s business (scope of competitor)? If not, stipulate a specific business of concern.
  • Is it really necessary to prevent the employee from working in all of Australia? (area) What should the area reasonably be?
  • Is it really necessary to prevent the employee from working for 6 months? (time) What should the time reasonably be? How much time is really need to protect the legitimate interests of the employer?

Cascading Restraint of Trade Clauses

In addition to carefully considering the question of reasonable necessity, drafters should consider using a clause that is not so generic and side step the trap of overreaching.

In all Australian jurisdictions, apart from NSW, if a restraint of trade clause is considered unreasonable, an employer will not be able to enforce the restraint unless some other agreement is entered into (which can be very difficult to secure in most cases).

In NSW pursuant to the Restraints of Trade Act 1976 (NSW), section 4(1) allows the court to ignore the fact that the restraint goes beyond what is reasonable, provided the restraint can be enforced to the extent that is reasonable.

The subsection permits the court to enforce a covenant whose provision is over extensive as regards area, time or extent. (Woolworths Ltd v Olson [2004] NSWCA 372 at [45]).

The Restraints of Trade Act 1976 (NSW) may be applicable where an employment contract (with a restraint of trade clause that continues to operate post-termination) has a close and real connection with NSW, for example, where the employer operates in NSW or where an employee provides services in NSW.

Therefore (except where a contract is governed by the law of NSW), drafting a single clause that is struck out for being unreasonable will generally mean there is no protection for employers. Thus cascading restraint of trade clauses are proving more and more useful.

The cascading restraint of trade clauses provide for different ‘levels’ of restraint, so that there are multiple options in relation to types of positions, types of businesses or activities engaged in by the future employer, geographic areas, and time lengths of restrictions.

Cascading restraint of trade clauses generally provide that each variable is treated as a separate clause, severable and independently binding on the parties. So while one combination of variables may be unreasonable, the employer may still enforce a less unreasonable restraint without the entire clause being struck out.

“The impugned part [of the clause] must be capable of simply being removed — as if simply crossed out with a blue pen; a court can remove words from a restraint clause but not rewrite it…” (Wallis Nominees (Computing) Pty Ltd v Pickett [2013] VSCA 24; See also Integrated Group v Dillon [2009] VSC 361; Hanna v OAMPS Insurance Brokers Limited [2010] NSWCA 267).

Cascading restraint of trade clauses can consist of a few combinations or thousands of combinations.

For example, in the case of Bulk Frozen Foods Pty Ltd v Excell [2014] TASSC 58, the Supreme Court of Tasmania found that a cascading restraint of trade clause containing 8,190 separate covenants was not unreasonable.

The court could not agree with the defendant’s argument that the restraint was void for uncertainty.

Ultimately it “comes down to whether the exercise amounts to a genuine attempt to define the covenantee’s need for protection, with the agreement as to severance as a precaution against the ‘all or nothing’ nature of the court’s tests for reasonableness”. (Lloyd’s Ships Holdings Pty Ltd v Davros Pty Ltd (1987) 17 FCR 505 at 522-523, applying JQAT v Storm [1987] 2 Qd R 162).

Enforcing Restraint of Trade Clauses

Litigating and Seeking Injunctive Relief

If an employer wishes to enforce a restraint of trade clause, it is essential that they act with no delay and seek an injunction (on an interlocutory basis) to restrain the former employee from taking up a new position, soliciting the employer’s clients, soliciting the employer’s staff; and/or making use of confidential information, as the case may be.

In order to be granted an interlocutory injunction, the employer must establish a serious question to be tried (that is, that a court is likely to find that the restraint is reasonably necessary to protect the legitimate business interests of the employer) and that the balance of convenience favours the injunction being granted.

When seeking an injunction, the applicant will usually also need to provide an undertaking as to damages. That is, if there is a subsequent trial, and the party seeking the injunction is unsuccessful, the applicant undertakes to pay all damages, that could have been foreseen, following from that injunction.

Depending on the injunction sought, these costs can be substantial and therefore careful consideration is required In the event that a court does grant an interlocutory injunction, there will often be negotiation between the parties to achieve an agreed outcome moving forward. Failing any such agreement, the matter will need to proceed to trial which may be a number of months following.

Pending the trial, the injunction remains on foot, and the employer’s interests are protected. As part of the trial, the employer may also seek damages for any loss they might suffer as a result of the breach of contract.

For example in the recent case of Andrews Advertising Pty Ltd v Andrews [2014] NSWSC 318 the court held that a restraint of trade clause, which prevented a senior executive from working for another advertising agency in Australia for a period of six months, was valid.

Further, the employee was order to pay his former employer $300,000.00 in damages for the breach of this contractual obligation.

No doubt enforcing a restraint of trade is a costly exercise, requiring significant time of sober reflection and consideration of a number of particular matters.

Conversely, all of this usually must be done urgently, and requires a costly commitment by the employer in terms of legal costs and energy.

Other Pre-litigation Questions

a. Is the restraint clause reasonable in the circumstances and likely to be upheld by a court?

As stated previously, whether the provision is reasonable is a question to be determined by looking to the facts of the case at the time the agreement was entered into. A thorough evaluation must be made having regard to the factors referred to earlier, as well as materially similar case law.

b. Has the employee been wrongfully terminated or made redundant?

There is argument at law to advance the view that where an employer has unlawfully terminated the employment of the employee or his or her position been made redundant, the employer may not be permitted to enforce the restraint because the employer is not coming with “clean hands”.

In the case of Ecolab Pty Ltd v Garland [2011] NSWSC 1095, Mr Garland was employed as a national sales and marketing manager for Ecolab Pty Ltd (“Ecolab”).

His employment contract provided a number of posttermination restraints including a 12 month restraint on being engaged in a competing business and a 12 months restraint on soliciting Ecolab’s customers and an obligation to not misuse confidential information of Ecolab.

Mr Garland’s employment came to an end when he was made redundant in May 2011. In July 2011, Mr Garland commenced working as a national sales manager for Karcher Pty Ltd (“Karcher”), which had been a customer of Ecolab previously.

Ecolab sought an injunction to restrain Mr Garland from working with Karcher, claiming that he had breached the post-termination restraints by soliciting Ecolab’s customers.

The court found that there was a serious question to be tried in respect of the breach of the non-solicitation restraint clauses. However, in relation to the non-compete restraint, the court did not consider that it would grant an injunction upon final hearing of the matter. The court made that finding based on a number of factors including the following:

  • Mr Garland “was not the author of his own misfortune”; Ecolab had “created” the current situation when his position was made redundant;
  • Mr Garland was made redundant by Ecolab after a representation was made that Mr Garland would remain employed with Ecolab.

When seeking to enforce a restraint upon a terminated employee, considered legal advice should be taken at this point.

c. Is it more commercially viable to offer to settle the matter?

It is usually advisable to consider the possibility of coming to an agreement with the employee by, for example:

  • Firstly, issuing a letter placing the employee on notice and directing them to cease and desist all acts that constitute a breach of the provisions;
  • Secondly, negotiating an agreement, which may for example involve instructing the employee to remain unemployed whilst the employer continues to pay the employee during the restraint period. This amount may be much less than one may ordinarily spend in commencing legal proceedings, depending on the situation. Note that the fact that payment is provided to the employee during the restraint period will not make an otherwise unreasonable restraint clause enforceable (Tullett Prebon (Australia) Pty Ltd v Purcell [2008] NSWSC 852).

Diligent Employer Actions

Diligent employers should take the following steps:

  1. Ensure that all contracts of employment are up to date and have restraint clauses that are reasonably necessary to protect the employer’s legitimate business interests, as at the time that the contract of employment is entered into, having regard to the particular individual employee’s position and the surrounding circumstances;
  2. Conduct interviews with, or write letters to, employees, particularly those who are high-risk departing employees, immediately following termination, reminding them of their obligations which survive termination;
  3. Act without delays if there is a concern that an employee may be in breach of the restraint clauses.

Contact

Our experienced Brisbane Employment, Industrial and Workplace Relations Lawyers offer their legal services, Australia wide (not just in Brisbane), throughout the entire employment relationship, from advice in the pre-selection and contract formation stage, through to advice on the relationship between employee and employer, through to advice when the employment relationship comes to an end (including acting and appearing in litigation as it relates to these matters).

We act for both employees and employers – this gives us a complete perspective when advising you as we understand what is of concern to you.

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