What is a reasonable restraint of trade clause? | Employment Law Update

An employment contract will often include a restraint of trade clause to protect the employer’s interests after an employee leaves their business. These clauses are most commonly found in the contracts of senior and professional employees, and also in business sale agreements.

The main types of restraint of trade clauses are:

  • Non-compete clauses that prevent a person from competing with their former employer for a certain time period. This could prevent them from starting their own business, or working for a competing business.
  • Non-solicitation clauses that prevent a person from soliciting their former employer’s clients for a certain time period.
  • Non-recruitment clauses that prevent a person from recruiting their former employer’s employees for a certain time period.
  • Confidentiality clauses that prevent a person from using their former employer’s confidential information.

To be enforceable, a restraint of trade clause must be reasonable. This means that an employer must be able to prove that they have a legitimate interest in imposing a restraint, and that the restraint is no wider than reasonably necessary. Restraints must be limited be time period geographical location, according to the employer’s particular need to restrain conduct. Usually, time periods of restraints will be limited to three to twelve months, but recent case law indicates that the courts are open to enforcing longer time periods in particular circumstances.

Southern Cross Computer Systems Pty Ltd v Palmer (No 2)

In the recent case of Southern Cross Computer Systems Pty Ltd v Palmer (No 2), the Victorian Supreme Court prevented an IT specialist from working for a competitor after it upheld a four year restraint period. Importantly, the restraint of trade clause relied on was not contained in an employment agreement, but an agreement to sell his 40% shareholding in the company. Justice McDonald found that the restraint afforded reasonable protection of the purchaser’s goodwill in the company that could be attributed to the shareholding.

The relevant restraint of trade clause was as follows:

During the Restraint Period, each Restricted Person must not, within the Restricted Area directly or indirectly, either on their own account or as an employee, member, shareholder, unitholder, director, consultant, adviser, contractor, principal, agent, manager, beneficiary, partner, associate, trustee, nominee, custodian, financier, representative, salesperson or in any other capacity whatsoever for any other person, firm, association or corporation (except as is expressly permitted by this agreement):

(a) Carry on, engage in or have any involvement in the Restricted Business.

Restricted Business was defined as ‘any business which is competitive with, or likely to be competitive with, the Business at the relevant time during the Restraint Period.’ Business was defined as ‘the business of IT procurement and associated IT managed services carried on by the Company.’

In finding that the four year restraint was reasonable in these circumstances, Justice McDonald had regard to a range of factors, including the length of his employment, his designation in the agreement as a ‘Key Employee’, the amount of consideration paid for the shares and restraint, and that the employee signed a one year employment contract with the company so that the restraint would not commence until the end of that agreement.

One factor that makes this case unique is that it involved a sale of shares. The courts have a greater tolerance of restraint of trade clauses in contracts for the sale of business as opposed to employment contracts. This is because the courts consider that a purchaser of goodwill is entitled to protection of that goodwill. If an employee sells a substantial shareholding of the business, then a long-term restraint is more likely to found to be reasonable.

How can you use restraint of trade clauses to protect your business?

There are a number of steps you can take to maximise the protection afforded by a restraint of trade clause:

  1. Ensure that contracts of employment contain restraint clauses with reasonable time and geographical locations. Consider what is reasonable to protect your genuine business interests. For example, it may not be reasonable to restrain an employee from competing with your business anywhere in Australia if you run a business that only services one regional area of New South Wales. The restraint should also be appropriate for the employee’s position and access to confidential information.
  2. Regularly review contracts to ensure that restraints reflect changes in business activities and employee roles. If an employee’s duties were substantially changed by the employer without obtaining the employee’s agreement, the employee may be able to argue that the employer repudiated the contract.
  3. When employees resign, ensure that you remind them of their post-employment obligations. If you consider a departing employee to carry a high risk of breach, formally remind them of their obligations in writing.
  4. Ensure that the employment agreement adequately covers confidential information and intellectual property. It should be made clear that any intellectual property created during employment is the property of the employer. The agreement should also contain clauses requiring the return of any records pertaining to confidential information or intellectual property, including both hard-copies and computer hardware.
  5. If you believe that an employee may be breaching a restraint, put them on notice as soon as possible and seek legal advice.
  6. If an employee is also an owner or shareholder of the business, be aware that the courts may be more lenient in considering the reasonableness of a restraint if the provisions are included in an agreement for the sale of that employee’s share of the business.
  7. If you suspect that an employee has taken confidential information, investigate their email account and IT systems. However, be aware that you can only access an employee’s emails it they have consented to access, as required by the Workplace Surveillance Act 2005 (NSW). This consent should be obtained in the employment contract.

Want to know more about restraint clauses? Are you looking for an experienced employment law solicitor in Newcastle, Sydney or the Hunter to assist you in your legal matter?  Call us on (02) 4929 7002, email us or complete an enquiry form.