People + Culture Strategies

Restraints of trade are not uncommon features of contracts of employment, particularly those involving mid to senior level managers and executives, but to what extent should your organisation consider trying to enforce any breach or imminent breach and what factors will a court give weight to in its decision (usually whether or not to grant injunctive relief)?

Contractual obligations post-termination, known as “restraints of trade” or “restrictive covenants” are generally used to prevent employees from engaging in a range of activities after their employment comes to an end such as not dealing with or approaching clients, not soliciting clients or employees and not competing with their former employer. Despite the fundamental principle that post-employment restraints are void as against public policy, over the years the law, through the varying Australian jurisdictions, has developed such that restraint clauses may be valid and justified in the circumstances of a particular case provided that the employer can demonstrate how the restraint reasonably protects the legitimate business interests of the employer. Organisations therefore need to be able to articulate to a court, in pursuance of such relief, what the interest is that they are seeking to protect, how the ex-employee is able to cause damage to it and that the way the employer is proposing to prevent this damage is reasonable in all the circumstances.

People must be able to earn a living – you can’t necessarily stop your competition

Non-compete clauses which operate to stop your ex-employees from working for a competitor tend to be the most difficult type of post-employment restraint to enforce. Courts are loathe to uphold these clauses where to do so would impose a significant and detrimental impact on a person’s ability to earn a living and certainly where it is only on the basis of prohibiting employees from working with a rival organisation.

One case established that to prevent the competition the employee has to have a legitimate interest in business connection or goodwill. It cannot be a “remote or tangential” likelihood of “genuine harm”. There is no protection from mere competition.

On the other hand, another case has noted that a non-compete clause is “a legitimate means by which an employer can prevent an employee from taking unfair advantage of information the employee has gained during the course of his or her employment. It is a means of avoiding the difficulties associated with proving breaches of behavioural restraints — such as an obligation to keep information confidential and not to use it or an obligation not to solicit the clients or customers of the employer for a period of time”. In another case, the Full Court of the Federal Court upheld an earlier decision in which it was found that a contractual clause which prohibited a company’s founder from working for two years after his resignation was reasonable in order to protect the business – the employee “accepted that he had been a key component” of his ex-employer’s success.

Can clients be stopped from choosing where to direct their custom?

The interest in preserving relationships with repeat or regular clients (as opposed to “one off” clients) has been recognised by the courts on a number of occasions. In one case, it was found that the employee was not in a “special category” that justified a restraint clause. The types of factors that were found worthy of a clause restraining an employee from dealing with clients were being a human face of a business, having control over a client’s business or fostering a special relationship. However an injunction was granted in the case here, because it was directed at preventing the employee from working for a select set of clients (not all of those of his employer) and it also did not prevent him from practising in his profession as an accountant. An injunction was also granted in this case to take into account the customer relationships and goodwill that two highly experienced marine insurance brokers would bring to the marine insurance area of any potential employer.

Confidential information – it is legitimate but can you identify it?

The legitimacy of confidential information as an interest to be protected has long been recognised but recent cases have turned on whether an employer can actually identify what that confidential information is and whether the range of confidential information over which protection is sought is too wide.

Cases have demonstrated that; advertising rates, website statistics that were not publicly available and brand plans were considered to be confidential, but customer addresses and contact details were not. In coming to this decision, the court held that the circumstances a court will consider regarding restraints on disclosure of information include:

“… (a) the extent to which the information is known outside the business; (b) the skill and effort expired to collect the information; (c) the extent to which the information is treated as confidential by the employer; (d) the value of the information to competitors; (e) the ease or difficulty with which the information can be duplicated by others; (f) whether it was made known to the employee that the information was confidential; and (g) whether the usages and practices in the industry support the confidentiality…”

The pivotal nature of being able to identify confidential information has been well illustrated in a case where one of the main reasons the claim for an interim injunction was refused was because the employer could not prove that the confidential information existed and if it did they couldn’t prove why it was confidential. On the other hand, in a different decision, the employer was granted an injunction in a situation where the former employee denied that he had access to a large volume of confidential information and the information that he did have access to would be outdated by the time he left as the employer was able to pinpoint information which would cause the employer detriment. The employer produced sufficient evidence to show that the employee had access to particular financial data, shipping schedules and price calculating tools that, if used against it, would damage the employer “probably permanently”.

The factors a court will have regard to in determining what is “reasonable”

The reasonableness of a restraint is usually judged at the time the contract is made and primarily relates to the length of the restraint, the geographical area in which the restraint operates and the restrictions that are imposed on the employee. All these should be no wider than necessary to protect the employer who must be able to demonstrate that it has an interest worth protecting including the damage which may be sustained if the restraint was not enforced.

In one case, it was held that it was not open for the employee to challenge a restraint on the ground of unreasonableness when the restraint was the result of a “genuine compromise” between the parties. The original restraint in the former employee’s employment contract had been altered in a deed of settlement when the ex-employee had left the employer and began soliciting clients of the plaintiff through his own real estate agency in breach of the restraint in the deed.

No damages without damage

Since restraints are contractual in nature, an employer must show that they have suffered damage as a result of the breach of a restraint of trade clause. Damages will not be awarded if the breach results in no loss to the employer.

In the case here, the employee resigned from her employment and began work with a direct competitor the next day. The court read down the non-compete and non-solicitation clauses to two rather than six months (on the basis that they went further than necessary to protect the legitimate business interests) and six months if limited to South Australia as opposed to within 20km of any premises from which it operated. Further, the court rejected the employer’s claim for $185,000 for the loss of 37 files citing that the evidence did not suggest that the employee had undertaken an active managerial or consulting role where she was capable of soliciting clients and the surge in the competitor’s client base was found to be coincidental. Therefore, it was not proven that the plaintiff was entitled to any measurable loss of damage on account of the breached employment restraint.

Cascading clauses

A cascading clause will not necessarily be unreasonable or uncertain because it contains a considerable amount of covenants with respect to alternative periods and geographical areas. In one case, an employee’s contract stopped him for acting in any of seven specified capacities across fifteen different businesses or activities. Other covenants were also included in this case. Each of the covenants had been stipulated and the court found that there had been a “genuine attempt to define the covenantee’s need for protection” therefore the clause could not be void for uncertainty.

Often cascading clauses are useful in jurisdictions where the courts do not have a discretion (such as in New South Wales) to read down the restraint to make it enforceable.