Restraints of trade in contracts of employment

Restraints of Trade, often included in contracts of employment, are a valuable tool for employers to ensure that their commercial and competitive interests are preserved after the employee/employer relationship ends. However, it is important if you intend to include a restraint, that it be enforceable, and able to stand up to testing by a Court if necessary.

What is a Restraint of Trade?

A Restraint of Trade is a term within a contract which can, among other things:

1. Prevent former employees from competing with their former employer (e.g. by commencing a similar business or working for a similar business). This is often set within a geographical radius or for a period of time (‘non-competition restraint’);
2. Prevent former employees from soliciting clients from their former employer for a period of time (‘non-solicitation restraint’);
3. Prevent former employees from soliciting current employees of their former employer for a period of time (‘non-recruitment restraint’); and
4. Prevent former employees from using confidential information obtained in the course of their employment (e.g. trade secrets) (‘confidentiality restraint’).

Validity of the Restraint

These kinds of terms can come unstuck easily, and must be able to stand up under scrutiny of a Court. Where the contract for employment relates to New South Wales law, the Restraint of Trade Act 1976 (NSW) (‘the Act’) will also apply in addition to general principles of Contract Law. The Act provides that the restraint must be in the interest of public policy in order to be valid.

Public Policy

As articulated by Markovic J in the relatively recent decision of Baker & McAuliffe Holdings Pty Ltd t/as JSB Lighting v Carey [2018] FCA 1972 (10 December 2018) (‘Baker’) the following questions will be relevant to determining whether the restraint is in the interest of public policy:

1. Does the employer have a legitimate protectable interest; and
2. Is the restraint no more than reasonable to protect that interest?

Baker was a case in which an employer sued its former employees for breaching a restraint that prevented them from soliciting former clients from the employer after their employment had ended. It is important to note that the decision was the hearing of an interlocutory, or interim, application to restrain the former employees from interacting with specific, longstanding clients of the former employer.

 Legitimate protectable interest

In Baker, Markovic J confirmed that:

“An employer is not entitled to be protected against mere competition. Rather, the legitimate interests of an employer which may be subject of protection by a restraint of trade clause are in the nature of proprietary interests, including trade secrets, confidential information and an employer’s goodwill including customer connection” (at 76 citing Koops Martin Financial Services Pty Ltd v Reeves [2006] NSWSC 449 at [28]-[29] (Brereton J))

In Baker, the legitimate interests of the Plaintiff were considered to be customer connections and confidential information. It is important to note that different legal questions arise in determining the legitimacy of different types of interest and accordingly, whether they are characterised as such. If you are unsure about whether a restraint is protecting a legitimate interest you should seek legal advice.

Reasonableness of the Restraint

The ‘reasonableness’ of a restraint is often considered in the context of how long the restraint operates for, or similarly, in relation to the geographical limitation imposed by the restraint. For example, a restraint which attempts to stop employees from working in a similar business within Australia, is likely to be unreasonable, for the simple fact that it would have the effect of preventing that person from obtaining gainful employment anywhere within the country. Similarly, where a provision attempted to prevent a former employee from working in a competitive business for an excessive amount of time, (e.g. 10 years), or indefinitely, it is likely to be unreasonable.

Saving the Restraint

Where the Court finds that the restraint is not in the interest of public policy or is generally unreasonable, the provision may be read down to ensure that the interests of the employer are protected. In practice it is common for there to be several “cascading” provisions in a restraint so that it may be easily read down by the Court. For example it may say:

1. The restraint period will operate for:
   • A period of 18 months from the date that the employee ceases to be employed by the company, unless that period is held invalid by any reason by a court of competent jurisdiction;
   • In which case, a period of 12 months from the date that the employee ceases to be employed by the company, unless that period is held invalid by any reason by a court of competent jurisdiction;
   • In which case, a period of 6 months from the date that the employee ceases to be employed by the company, unless that period is held invalid by any reason by a court of competent jurisdiction.

In practice it is important to ensure that restraints are properly drafted to ensure that they are firstly, not too burdensome on the former employee, and to ensure that they properly protect the employer.