Except in New South Wales, the starting point in relation to restraint of trade clauses is that they are presumed by the Courts to be void. The onus is on the enforcing party to satisfy a court that a restraint goes no further than reasonably necessary.
Restraints are most commonly drafted in severable, or cascading, terms, which list a number of possible combinations of restraint areas, restraint periods and restrained activities. This allows a court to invoke the “blue pencil” rule, which allows the court to strike out the unenforceable parts of the restraint, and leave the enforceable parts standing.
In New South Wales, restraints of trade are not presumed to be void. The Restraints of Trade Act 1976 (NSW) allows the Supreme Court of New South Wales to uphold a restraint to the extent it is reasonable, even if the clause is not drafted in severable terms.
Importantly, restraint of trade clauses often specify that the employee will not directly or indirectly accept work or instructions from a client of their former employer even as an employee or agent of another company in circumstances where the former employee has no relationship to that client.
This presumption of validity of the clause can be challenged, however. The law allows the use of restraint clauses where it can be proven that there were “special circumstances” which made it necessary to protect the interests of the parties, therefore a defence to validity, and therefore enforceability, is that there are neither special circumstances nor need for any protection of the business.
In assessing what type of protection will be regarded as reasonable, an employer must identify a relevant risk such as the risk of the loss of business to a competitor by the use of a personal connection with clients and information about those clients. The clause must not impose more than adequate protection and if it goes beyond this then it will be considered unreasonable.
The relevant factors are:
The nature of the business and whether confidential information was obtained that was specialised knowledge not ordinarily obtained in the course of employment;
2. A comparison between the former and current positions of the employee within each company;
3. The composition and value of the of the client/customer base, and
4. The length of the restraint provision and its reasonableness.
Fearing the loss of clientele is not enough to make an application to the court. A clause can be struck down if it is too wide, for example it prohibits employment throughout the whole of the state, or you cannot prove that it is designed to protect some legitimate interest such as intellectual property or a unique business product. In one case an employer was unsuccessful because the employee’s new role was deemed different to the services offered by the former employer. The court found that because only 30% of the old role was being performed in the new role, the employer had failed to identify a legitimate interest that required protection by the clause and was deemed to have gone further than was reasonably necessary to protect its interests.
However, in another case, an employee’s close and intimate knowledge of management and clients resulted in a two-year restraint clause being enforced. Even a close connection with the customer may not be sufficient, what is needed is a strong connection including personal or special knowledge “client connection”, which may include confidential information of the client and a significant degree of influence.
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.
The Supreme Court of New South Wales granted an interim injunction restraining a senior property manager from starting employment with a competitor pending a final hearing.
- The employee had become employed by the employer where the employer bought a rent roll from the employee’s former employer for $1.3 million
- The employee commenced employment on 31 October 2016, but had not signed an
employment agreement with restraints until 23 April 2019
- The employee was made redundant on 12 November 2019
- The employee did not receive any additional financial benefit for agreeing to the
- A three year, 15-kilometre non-compete restraint
- A three year non-solicitation and no dealing restraint.
- The judge granted an interim injunction restraining the employee from starting employment with a competitor pending a final hearing because the protection afforded by non-solicitation and confidentiality provisions is unlikely to be perfect because it is often difficult to prove a breach. Although the employee had given back copies of customer lists and databases, such information would be retained in her memory and there was a risk she may inadvertently use that information for the benefit of her new employer and to the detriment of her former employer.
- The judge observed that the non-compete may be enforceable, but the non-compete restraint may be read down to less than three years, and possibly less than 12 months. The judge further observed that while there may be questions about the reasonableness of a three-year restraint for the non-solicitation and no dealing restraint, 12 months may be reasonable.
The Supreme Court of Queensland refused to enforce three-year non-compete restraints contained in the standard REIQ Contract Business Sale (Second Edition), an employment agreement and a settlement agreement
- GBAR (Australia) Pty Ltd (GBAR) bought an asbestos removal business from Brown & Cremin Pty Ltd (B&C) for $2.454 million
- The business sale contract was in the form of the REIQ Contract Business Sale (Second Edition) with special conditions annexed
- Mr Brown, who controlled B&C, was employed by GBAR from completion of the business sale
- B&C owned 20% of GBAR
- After B&C exited GBAR as shareholder and Mr Brown exited as an employee, Mr Brown set up a new competing company
- The evidence revealed that Mr Brown had not solicited clients from GBAR, but they had left GBAR on their own accord
Restraints in dispute
- A three-year, Queensland-wide non-compete restraint contained in the standard REIQ Contract Business Sale (Second Edition)
- Three-year, Queensland-wide non-compete and non-solicitation restraints included in Mr Brown’s employment agreement
- A three-year, Australia-wide non-compete clause included in a settlement agreement whereby B&C exited GBAR as shareholder and Mr Brown exited as an employee
- The non-compete clause included in the REIQ Contract Business Sale (Second Edition) was not enforceable against B&C because existing customers returned to GBAR for Mr Brown’s experience and reputation and GBAR failed to restraint Mr Brown personally. Further, the non-compete clause could not be enforced directly against Mr Brown because he was not a party to the business sale contract
- The enforceability of the restraints in the employment agreement were not determined by reference to the usual inequality of bargaining power between employer and employee, but rather they were assessed in light of the broader commercial transaction effected by the business sale contract. A three-year, Queensland-wide non-compete restraint was assessed to be unreasonable, but it was not necessary to reach any conclusion because the parties had agreed to expand the restraint obligation in the settlement agreement from Queensland to Australia.
- As to the enforceability of the non-compete restraint in settlement agreement, its validity was assessed by the principles relating to a restraint between an employer and an employee, rather than those relating to the sale and purchase of a business, because the settlement agreement included no additional compensation for the restraint. The three-year, Australia-wide non-compete restraint was not enforceable because seeking to restraint Mr Brown from working anywhere in Australia went beyond restricting Mr Brown from working in those places where GBAR traded. The judge overserved the non-compete clause would have still been unenforceable even if it was assessed by the principles relating to the sale and purchase of a business.