Nichola Constant and Erin Lynch outline the role of restraints of trade, including non-compete clauses, and what recent findings from the Federal Court mean for business.
Court decisions continue to indicate that restraints of trade, including non-compete clauses, will be enforced if reasonable and necessary to protect legitimate business interests.
‘Restraint of Trade’ provisions are now routinely found in employment, partnership and sale of business agreements. These provisions seek to prevent employees or partners from taking clients or competing with the business for a period of time after they leave.
Drafting an effective clause
A court will only enforce restraint clauses if it considers the restraint ‘reasonable to protect the legitimate business interests’ of the party seeking to enforce the restraint (the ‘restrainer’). If the restraint clause is not ‘reasonable’, a court is likely to find the whole clause void and unenforceable and it may be struck out of the contract. Normally, courts do not have the discretion to rewrite clauses.
However, in New South Wales, the Restraints of Trade Act 1974 does allow a court to ‘read down’ the terms of a restraint clause to modify it (as to the time period or geographic area, etc) until it is reasonable.
‘Cascading’ clauses offer a number of alternative covenants, detailing the time and geographical limits of restraint. The advantage to these is each one is severable by a court without affecting the validity and enforceability of the restraint.
What is reasonable?
It is reasonable to protect a business’ goodwill for a period of time by placing restrictions on a former employee’s business activity.
Many factors are considered when concluding whether a restraint is reasonable. Each situation is unique. Factors include (but are not limited to) the influence of the person being restrained and how integral they are, or were, to the business. The type of information requiring protection may include trade secrets, customer lists, access to clients and/or prospects and the relationships established through the business.
In principle, courts will look at whether the restraint protects a genuine interest of the restrainer and whether the time period and geographical area are no greater than required to protect that interest.
The Full Court of the Federal Court of Australia has recently revisited restraint of trade clauses in employment contracts and upheld a two-year restraint period against a former director.
Brent Pearson was a director of HRX Holdings Pty Ltd. Mr Pearson agreed to a restraint that prevented him from accepting employment with a business ‘similar to or competitive with’ HRX for two years after termination of his employment. The restraint was designed to stop him disclosing confidential information and soliciting customers or employees away from HRX.
In exchange, Mr Pearson received his salary for all but three months of the two years and an eight percent shareholding in HRX confirming the restraint was a part of a “reasonable commercial arrangement between the parties”.
Mr Pearson subsequently resigned from HRX. A week earlier he had accepted a senior position with a competitor.
The Court held that: “Where a contractual restraint protects a legitimate interest of the covenantee, the restraint must afford no more than reasonable protection as between the parties and in terms of the public interest. In terms of HRX’s interests, the restraint in protecting customer connections and ensuring the diligent and faithful pursuit of business opportunities by Mr Pearson for HRX, was reasonably necessary to protect those interests.”
What must you do to ensure a restraint clause can be relied upon?
From the substantial cases dealing with restraint clauses it is becoming clear the requirements for a restraint to be held reasonable are:
• Genuine interest—you must have a genuine and legitimate interest that needs protecting and the restraint should be limited to protecting that interest;
• Time period—the restraint should last no longer than necessary to protect that interest;
• Geographic area—the restraint should not cover a geographical area larger than necessary to protect that interest;
• For employees—ensure the restraint is not so broad as to prevent the employee from working at all; and
• Cascading clauses—with alternative time periods and geographic areas, this may help to ‘hedge your bets’.
It is critical to identify precisely the interest that needs to be protected. In determining this, consideration must be given to the employer’s ‘business’, the area in which protection is required, and the time frame - and then limit the restriction accordingly. Be wary of any ‘standard’ clauses. If they do not suit the specific circumstances, they may be unable to be enforced.
Contact the authors
Nichola Constant can be contacted on +8094 3102, email@example.com and Erin Lynch on +8094 3115 or firstname.lastname@example.org