What are restraint of trade clauses?
Restraint of trade clauses are often included in contracts of employment as a way for employers to protect their business interests by restricting an employee’s freedom to undertake certain activities during or after ending their employment.
Examples of restraints commonly found in employment contracts include:
- Confidentiality clauses – prevents an employee from disclosing or using their former employer’s information.
- Non-compete clauses – prevents an employee from entering or starting a similar profession or trade in competition with their former employer.
- Non-solicitation clauses – prevents an employee from soliciting or ‘enticing away’ the clients or customers of their former employer.
- Non-recruitment clauses – prevents an employee from recruiting their former employer’s workers.
As we will see, the extent to which any such clauses are actually effective and enforceable will depend on the particular circumstances of the case.
Are restraints of trade enforceable?
Generally, it is said that all agreements to a restraint of trade are presumed to be unenforceable, unless the restraint is shown to be reasonable. This means that even though you may have voluntarily accepted post-employment restrictions in your contract, the starting position is that these will be void and have no effect.
In New South Wales this presumption is reversed – instead, a restraint of trade is presumed to be valid but only to the extent that it is not against public policy. A restraint will be considered against public policy if it is found that there has been a ‘manifest failure’ by the employer to attempt to keep it within reasonable bounds.
These presumptions may seem confusing, but the key point to take away is that restraints will be enforced only insofar as they are reasonable.
When is a restraint reasonable?
Establishing reasonableness involves proving two elements:
- The employer has a legitimate interest in imposing the restraint; and,
- The scope of the restraint is no wider than is reasonably necessary to protect that legitimate interest.
What is a legitimate interest?
Legitimate interests generally include commercial interests or goodwill (the intangible assets of a business such as reputation, customer relations, and proprietary technology).
Situations in which the courts have recognised that the employer has a legitimate interest in imposing a restraint include:
- Where an employee has access to confidential information and may be able to use it to the detriment of their former employer.
- Where an employee has contact with the employer’s customers as part of their work and may use those connections to entice customers away.
- Where an employee is in a position to recruit colleagues from their former employer.
In each of these situations, the courts have recognised that there is a legitimate interest which may be threatened, and therefore requires protection.
The employee’s former position is commonly a consideration relevant to establishing whether any of the above situations apply to their circumstances. For example, a restraint may be more reasonable when imposed on senior employees who have had access to trade secrets or direct contact with customers.
Note, however, that generally the employer may not impose a restraint of trade merely to prevent competition from former employees or to stop a valuable worker being employed by another business.
What is a reasonable scope?
The scope of the restraint must be no more than is reasonably necessary to protect the employer’s legitimate business interests.
Whether a restraint is reasonable in its scope will depend on three key considerations:
- The duration of the restraint;
- The geographical area in which it is to have effect; and,
- The activities that it purports to control.
Each of these considerations will have to be weighed in the particular circumstances of each individual case. Where a restraint is unreasonably wide, an employee may apply for a court order invalidating or narrowing the restraint. Unless there is absolutely no legitimate basis for having a restraint, generally the courts will narrow the scope of the restraint so that the employer may still have partial enforcement of the restraint to the extent that it is deemed reasonably necessary. This is called ‘reading down’ a restraint.
For example, a court may find that a restraint with effect over all of Australia is too wide because the employer’s business only operates in New South Wales. The court may then ‘read down’ the restraint so that it is only applicable within New South Wales.
Other examples of where a restraint has been found to be too wide include:
- Where a restraint prevented employment across the entire plastics industry. The court held it should have been limited to the particular part of the plastics industry in which the previous employer operated.
- Where a restraint prevented an employee from dealing with a class of clients, not all of whom had sufficient contact with the employee for there to be a threat of those clients being lured away.
- Where a restraint prevented an employee from working with a list of competitors, it was only effective in respect of those businesses that actually competed with the employer.
- Where an employee could be terminated on only one month’s notice within the first six months but restrained from working for two years.
- Where the length of the restraint on dealing with the employer’s customers was longer than it would have taken a reasonably competent replacement employee to establish a rapport with the customers.
Ultimately though, it will come down to the unique circumstances of your particular case.
How can a restraint be enforced?
Usually an employer will seek a remedy called an injunction when they are looking to enforce a post-employment restraint. This is a formal court order which, if successfully claimed, enforces the restraint to prevent the employee from undertaking those activities identified in the restraint.
Generally, an employer will also apply for an ‘interim’ injunction prior to a full trial. This is a temporary injunction which has effect whilst the court is deliberating on the actual claim for injunction. In practice, the outcome of the application for interim injunction will generally be decisive and the matter will be settled in accordance with that decision, rather than proceeding to a full trial.
Restraint of trade clauses can impose serious restrictions on your future liberties, particularly your ability to find work. With this in mind, it is essential that you seek legal advice to ensure that your rights are not being unduly restricted.
Contact us on (02) 9199 8597 for a deeper discussion of how these issues may apply to your situation.