A post-sale restraint is a contractual provision that limits a seller's ability to compete with the business they have sold.
Every lawyer knows that restraints will be void at common law and unenforceable on the basis that they are "unreasonable" if they seek to do more than protect the legitimate interests of the buyer in protecting goodwill of the business that has been sold.
However, the decision of DXC Eclipse Pty Ltd v Wildsmith [2023] NSWCA 98 is a useful reminder of six key issues to consider in negotiating and enforcing post-sale restraints.
The post-sale restraint and alleged breach
In April 2018, DXC Eclipse Pty Ltd, a software solutions company, purchased another software solutions company called Sable37 by way of a Securities Purchase Agreement. The Agreement contained a post-sale restraint clause, which prohibited Mr Wildsmith, a former owner and also the Managing Director of Sable37, from competing with DXC for a period of up to seven years.
In 2021, Mr Wildsmith incorporated a new venture called Will Thirty Three Pty Ltd, also offering software solutions.
DXC brought proceedings to enforce the post-sale restraint in the NSW Supreme Court in March 2022, on the basis that Mr Wildsmith's new business venture violated the post-sale restraints.
The Court at first instance found in favour of Mr Wildsmith, holding that the restraints were unreasonable and unenforceable because they were overly broad in scope and not necessary to protect DXC's legitimate business interests.
The Court of Appeal upheld the primary judge's decision.
1. What exactly is the "business"?
Consistent with normal practice, the restraint clause in this case was cast as an undertaking to not engage in activities which compete with the "business". The "business" was then defined by reference to the business activities of the company being sold – but also to "future, successor or derivative" products.
The Court confirmed that although the "business" being protected for the purposes of post-sale restraints could include an element of potentiality, it needs to have some element of connection with products or services the business had at the time the Agreement was made – otherwise the restraint goes beyond protecting the buyer's legitimate interests.
2. What if the competition is only "slight"?
The test for whether the seller's activities "competed" with the business is whether the seller's activities "might pose a real commercial threat" to, or would compete with, the business "seriously". If the seller's product is not a direct substitute for the products of the "business", it is unlikely that the threshold for competition will be met.
In this regard, the Court not only considered the software's functionality, but the extent of any likely overlap in customers for the product.
It held that any potential for competition was slight or insubstantial – and was not enough to establish a breach of a post-sale restraint to not "compete" with the business.
3. Can non-solicitation restraints also be unreasonable?
The Court also found that restraints prohibiting the seller from:
- poaching employees from any member of the buyer's corporate group; or
- dealing with one of the key suppliers of the business (Microsoft) which did not harm the business,
were unenforceable.
The Court held that an employee non-solicitation restraint which extended beyond the employees of the business at the time of the sale (eg. included employees of the buyer group) was not reasonably necessary to protect the goodwill of the business that was sold, and therefore unenforceable.
In relation to the non-solicitation restraint concerning the supplier, the Court noted that while supplier relationships may be a source of goodwill, for a restraint to be enforceable, it must concern activities which have an adverse effect on the relationship between the business and the supplier. If not, they are not reasonably necessary to protect the goodwill of the business and are not enforceable.
4. Is the restraint too long to be enforceable?
The reasonableness of the duration of a restraint is determined by considering how long it takes to protect the buyer's goodwill from being subtracted by the seller. While the assessment of whether a restraint is reasonable is to be made at the time the agreement is entered into, the Court confirmed that in determining whether to exercise its discretion to grant the injunctive relief, it may consider the circumstances at the time the relief is being sought.
Accordingly, the buyer would need to demonstrate how or why (at the time the injunction is being sought) it would be deprived of the benefit of goodwill it acquired under the agreement as a result of the seller's activities. In considering this question, the Court was prepared to take into account the fact that the Mr Wildsmith had worked in the business for three years following completion, which greatly enhanced the buyer's ability to fully realise the benefit of the goodwill.
5. Buyer has onus to prove the restraint is reasonable
The buyer has the onus of establishing the reasonableness of the restraints which it seeks to enforce. The buyer must therefore establish that it has a legitimate interest that is worthy of protection (ie. goodwill of the business) and the restraint is reasonably necessary to protect the buyer's legitimate interests.
Further, to obtain an injunction, the buyer must also establish that the injunction is necessary (at the time it is being sought) to ensure that they are not deprived of that goodwill.
6. Competition and Consumer Act
While this case only considered common law questions of enforceability of a restraint, it should not be forgotten that a restraint which is cast too broadly can also give rise to a contravention of the Competition and Consumer Act – and that the potential for such contraventions should not be overlooked.