Workplace Relations Insights

10 July 2007

Restraining an employee from working with a competitor

By Dr Graham Smith.

Key Points:
Restraint of trade clauses should be carefully and clearly drafted.

Restraint of trade clauses in employment contracts are not always regarded as valid by the courts. The restraint must be "reasonable" as to the time period and the geographical area. Recently, the Supreme Court of Western Australia upheld the validity of complex clauses restraining an employee for six months from working with a competitor company: Nomad Modular Building Pty Lt v Smith [2007] WASC 117.

Background

The defendant was engaged as head of the manufacturing section of the plaintiff company Nomad Modular Building Pty Ltd on 7 March 2006. He gave notice on 7 March 2007 that he was resigning from Nomad with effect from 30 March 2007. He intended to become an employee of Australian Portable Buildings Pty Ltd ("APB") and signed an employment contract with APB.

Nomad sought injunctions to restrain Smith:

  • from commencing employment with APB until 30 September 2007
  • from inducing, encouraging or soliciting a contractor or agent of Nomad to cease providing services to Nomad or a related entity; and
  • from divulging or using the confidential information of Nomad for other than Nomad's purposes.

Contractual clauses

The contract of employment entered into between Nomad and Smith contained the clauses relating to confidentiality, non-competition, and non-solicitation.

The confidentiality clause which prevented disclosure of confidential information was not limited in time or geographical area.

The non-competition clause, which was directed at preventing the employee either directly or indirectly competing against the employer was limited to Queensland and Western Australia and for a period of six months from the contract termination date.

The non-solicitation clause was "unhappily worded", according to the Supreme Court, but its purpose was to prevent Smith interfering with Nomad's "contractual relations with sub-contractors or soliciting those sub-contractors away from" Nomad.

Confidentiality clause

The Court rejected Smith's argument that he had not come into possession of confidential information: being head of manufacturing section, it "is inevitable that he, during his 12 months of employment, picked up concepts and technical and operational information used by the company. He also undoubtedly had an insight into the financial affairs of the plaintiff", which was confidential information.

The Court, however, refused to grant the injunction to restrain Smith from divulging confidential information as there was no evidence that Smith either intended to disclose such information to his new employer or anyone else, or that he had done so.

Non-solicitation clause

The Court held that it would not also grant an injunction in relation to the above clause as there was no evidence that Smith either intended to solicit clients or that he had solicited Nomad's clients.

Smith sought to have the clause struck out as being a restraint of trade. The Court held that the clause was reasonable:-

"Effectively what the plaintiff is seeking to do is protect its relationship with certain of its customers who were acquainted with the defendant and protect itself against the loss of employees, contractors or agents who undertake its work. The period of six months is probably the maximum which could be reasonably applied, but I do not see it as unreasonable. It is a question of balancing the interests of the parties."

Non-competition clauses

The Court identified four matters to be taken into account to determine whether a restraint is reasonable:

(1) the party benefiting from the restraint must have a genuine interest in requiring protection

(2) the restriction is limited to the covenantee’s interest

(3) the period of restriction is "no longer than necessary for the protection of that interest"; and

(4) the geographical area in the restriction is no longer than necessary for the protection of that interest.

The Court held that the matters (2) to (4) would not restrict the former employee from employment with a company which was not making portable buildings. The restrictions of time (six months) and geographical area were no longer or wider than reasonable to protect the employer’s interest. The restriction was not unlimited.

Matter (1) was in issue. The former employee argued that "there was no legitimate interest which the clause sought to protect" and that it stifled competition.

The Court rejected the argument, holding that the clause protected a legitimate interest. It referred to the UK case of Littlewoods Organisation Ltd v Harris [1978] All ER 1026 in which the English court stated that a clause simply prohibiting disclosure of confidential information may not be satisfactory because of the difficulty of drawing a line between confidential and other information, and proving a breach when employees can take information away in their heads. In the words of the English court: "The difficulties are such that the only practicable solution is to take a covenant from the [employee] by which he is not to go to work for a rival in trade. Such a covenant may well be held to be reasonable if limited to a short period".

The WA Supreme Court held that this was such a case. While it was not suggested that Smith would disclose confidential information or solicit customers, the court thought that without limiting the defendant there were risks that he might do so.

If APB were to develop its business in Queensland, it would not be practicable to suggest that Smith would not use information to favour his new employer and potentially damage Nomad.. Nomad has no way of knowing when and if that might happen. So to prevent the situation arising, a reasonable restraint clause was placed in the employment agreement. It should be allowed to operate as between the parties, held the Court.

The Court granted the injunction to restrain Smith from working for APB until 30 September 2007, that is, until after the expiration of the restraint period.

Implications for employers

This case reinforces the position that restraint of trade clauses should be carefully and clearly drafted. They cannot be unlimited as to time or place. They cannot usually prohibit an employee from ever working with a competitor. In limited circumstances, however, a restraint from working with a competitor will be valid and an injunction may be granted to compel adherence to the restraint.

Employers which impose wide and unlimited restraints clauses on employees run the risk that the whole clause may be declared invalid and will be unenforceable. This means that a lesser restraint as to time or area may not operate.

Thanks to Marilyn Pittard for her help in writing this article.

For further information, please contact Dr Graham Smith.

Disclaimer
Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this bulletin. Persons listed may not be admitted in all states or territories.