Do restraint of trade clauses make sense?

'The difficult and costly process' of non-competes 'prevents most employers from even trying'

Do restraint of trade clauses make sense?

Non-complete clauses in contracts are often found in competitive industries where intellectual property is at a premium.

While they are not always easy to enforce, depending on the specific contract terms along with the length of time stipulated, they are important for employers to seriously consider, if they don’t want employees taking their ideas to competitors.

Industries that rely on personal relationships, such as professional services such a lawyers, accountants, medical professionals, or where proprietary information provides a competitive advantage such as the IT or tech industries, are more likely to have non-compete clauses.

“Employers use restraint of trade clauses to restrain employees from taking certain actions following the end of their employment,” John Pegg, senior associate – business, corporate and commercial Holman Webb Lawyers, said. “This usually relates to the protection of trade secrets and confidential information such as client lists for example.”

The common law view of restraint of trade clauses is that these are contrary to public policy and are void, he said.

“However, New South Wales is the exception, with the Restraint of Trade Act 1976 (NSW) modifying the common law so restraints are — on the face of it — enforceable, provided it is not contrary to public policy.”

In a recent case from the Fair Work Commission, a senior employee claimed unfair dismissal after the employer alleged that he breached his confidentiality obligations for disclosing information to a client. The employee argued he was obligated to disclose the said information.

From the beginning

Employers are encouraged to have new employees sign non-complete clauses at the beginning of their contract. They must clearly state the terms and conditions and ensure that the employee not only understands them, but also is in agreement that any breach will result in further action being taken.

The vast majority of non-complete clauses protect the business from being exploited and safeguard business practices and clients list from being stolen.

“Typically, restraint clauses are drafted to prevent an employee from competing with the former employer in a similar role; poaching staff from the former employer, soliciting clients or customers from the former employer; and getting a third party to do the above,” Pegg said.

These restraints are usually drafted to operate within a certain area, known as the restraint area or a particular period of time, which is known as the restraint period, he said.

“The common approach is for the restraint area and restraint period to be drafted as cascading clauses, meaning that it lists a few different periods of time or geographical locations.

“This drafting technique is popular because courts will typically use the ‘blue pencil test’ in determining whether a restraint is enforceable. This involves the court ‘reading down’ a restraint provision to ensure it is more reasonable.

It’s called the blue line test because the court will cross out the parts of the cascading provision that are unreasonable, said Pegg.

“Using the above example of a restraint period, a court may find that a restraint period of 12 months is unreasonable, so will cross it out. The result is that the restraint period is for a period of nine months,” he said.

“If it is not drafted as a cascading provision and only one restraint period is listed, then the risk is high that the whole clause may be unenforceable as there are no alternative restraint periods for the court to consider as reasonable.”
Non-compete clauses usually range from six months to 12 months from termination of employment.

Previously, HRD looked at the basics of non-disclosure agreements.

How enforceable are they?

Non-compete clauses are heavily scrutinised by the courts who will closely examine the terms of the contract.

“They are notoriously unenforceable,” Jo Alilovic, director, 3D HR Legal, said.

Courts start from the position that a non-compete is invalid, she said, putting the onus on the party seeking to enforce it to prove it is reasonable.

“The difficult and costly process prevents most employers from even trying.”

However, these clauses are enforceable if written well and appropriate in the circumstances.

“For example, in a recent case, Employsure successfully argued a business sales manager’s restraint of nine months was reasonable because there was a legitimate interest to protect, and the manager had access to relevant confidential information,” Alilovic said.

“Often, it is more effective to focus time and resources on retaining clients and staff rather than enforcing restraints.”

A 2016 study found Australian Courts enforced employment contract restraints in 46% of the cases that came before them, she said.

“An interesting fact is that 55% of the total 145 cases over 23 years were in NSW which has the Restraint of Trade Act.”

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