28 Apr 2022

Restraints of trade in the employment context 02: Understanding non-compete clauses

By Jennifer Wyborn, Nicholas West-Foy and Sarah Pain

It is clear from the case law that there is no one answer as to what constitutes an acceptable restraint and whether a restraint will be held as valid by a court will depend on the circumstances of the individual case.

As noted in the first article in this series, there are typically two main types of restraint of trade clauses; non-competition clauses and non-solicit clauses. This article will look at non-compete clauses in more depth.

What is a non-compete clause?

Put simply, in an employment context, a non-compete clause restricts an employee’s ability to compete for business with their former employer once the employment ends. The primary purpose of the clause is to protect the legitimate business interests of the employer.

During their period of employment, employees will often develop a significant amount of knowledge about their employers, including confidential information in relation to business practices. Depending on the nature of their role, an employee may also develop strong relationships with clients or suppliers. A non-compete clause prevents a former employee from utilising this knowledge, that they otherwise would not have, to compete with their former employer for business.

While a non-compete clause will not be enforceable where it unreasonably attempts to prevent a former employee from ever working or competing in the same industry again, a well drafted clause may be able to restrict competition for a particular length of time and within a particular geographical location.  

What can a non-compete clause cover?

As a general position, an employer cannot use restraint clauses to protect itself from any competition from former employees. This is because at common law, restraints of trade themselves are considered contrary to public policy and therefore void. This includes a former employee:

  • establishing a competing business; or
  • beginning employment with a competitor of the business

However, in certain circumstances, a clause which restricts this activity to a certain degree may be deemed valid, provided it is aimed at protecting a legitimate proprietary interest of the entity seeking to impose it (in addition to satisfying the reasonableness test set out in the Second Limb). This exception was explained by the NSW Supreme Court in Allied Express Transport Pty Ltd v Braim [2022]:

"negative covenants restraining employees from competition against an employer will only be enforced to the extent that those covenants are necessary for the reasonable protection of the business interests of the employer and that an employer is not to be protected from mere competition per se by employees that have ceased employment with that entity."

It is also important for employers to understand the distinction between:

  • an employee's personal skill and experience gained during employment, which is not protectable via a restraint; and
  • the knowledge of some advantage or asset inherent in the employer's business (eg. a trade secret or confidential information) which can be regarded as proprietary property of the employer and therefore protectable.

As articulated by the NSW Court of Appeal in Jardin v Metcash Ltd:

"the employer is entitled to protection against the use of 'personal knowledge of and influence over' its customers, which the employee might acquire in the course of his or her employment, so as to undermine its customer connections. It is against this 'possibility' of its business connection being adversely affected by the use of that 'personal knowledge and influence' that the employer is entitled to be protected. " [emphasis added]

When will a non-compete clause satisfy both limbs?

A restraint of trade clause will only be enforceable where an employer has a legitimate protectable interest and the clause itself restrains no more than what is reasonable to protect that interest. The onus is on the employer to show that any restraint is reasonable to protect their interests in the circumstances.

Legitimate protectable interest

Legitimate protectable interest (the first limb) includes a business’ “goodwill” and customer connections, and well as trade secrets or confidential information obtained during their employment.

(a) Goodwill

The Federal Court explored the concept of goodwill in Findex Group Limited v McKay [2019] FCA 2129:

“Goodwill” has an established and wide meaning… it includes “whatever adds value to a business by reason of situation, name and reputation, connection, introduction to old customers, and agreed absence from competition”. Also, “[i]t is the benefit and advantage of the good name, reputation, and connection of a business. It is the attractive force that brings in custom. It is the one thing that distinguishes an old established business from a new business at its first start.”

Goodwill takes time to build, and a business owner will want to protect itself not only through its connection to existing customers (non-solicit) but also its established reputation.

(b) Trade secrets or confidential information

An employer may also restrain a former employee from using trade secrets or confidential information. Throughout the course of employment, employees will often be dealing with confidential or sensitive information in relation to the business, which they otherwise would not have access. This may include information in relation to clients such as contract terms or expiry dates, and business pricing models. This is recognised as a legitimate protectable interest and a reasonable restraint can be used to protect the employer from being commercially disadvantaged from use of this information.

Reasonably necessary

The second element to consider is whether the restraint is reasonable, in that it is no wider than what is reasonably necessary to protect the legitimate interest identified. While there is no universal standard as to what is reasonable and it will ultimately depend on the factual circumstances, there are several criteria which a Court will consider:

  1. The period of restraint

    A restraint cannot be for an unlimited period of time, and employers must consider what is reasonable to protect the interest. For example, in order to protect goodwill and customer connections, consideration may be give to the length of time over which advantages of personal connection and knowledge may diminish (Habitat 1 Pty Ltd v Formby [No 2] [2017] WASC 33). Employment contracts will often include cascading restraints, which provide variations in the restraint period, in the event that the longer period is found to be unreasonable. It is always preferable, however, to have a defined and set period of time and good reasons supporting why that time period is appropriate.

  2. The geographical area to which the restraint applies

    A restraint must also be limited to the area in which it genuinely protects the employer’s business interest. In considering this, it will be relevant as to the area in which the employer conducts their business and the size of the geographical area in which they are trying to restrain their employee. In AECI Australia Pty Ltd v Convey [2020] QSC 207, the court found an Australia-wide restraint was too wide to cover the legitimate business interests of AECI, noting that the restraint “extended well beyond the sphere of AECI’s competition”.

  3. The nature of the employee’s role

An important consideration will always be the employee’s position in the business at the end of their employment. A restraint is more likely to be reasonable when applied to a senior or executive level employee who is privy to substantial business knowledge. In DP World Sydney Ltd v Guy [2016], the NSW Supreme Court determined that:

"Having regard to the seniority of Mr Guy's position, the nature of the plaintiff's business, the small number of competitors operating in the same port as DPW and, in particular, the confidentiality of the information that Mr Guy would be expected to obtain and use and which he did so acquire, I think such a six-month restraint is not larger than is reasonably necessary to protect DPW's legitimate interests in preserving its confidential information."

The level of contract or relationship an employee has with customers and clients is also an important consideration, to the extent they can capitalise on this personal relationship in competition with their former employer. This was highlighted this in Tullet Prebon (Australia) Pty Ltd v Simon Purcell:  

"this is a classic case in which the individual broker is the persona of the employer in dealing with clients, but the employer invests considerable sums in building customer connection, including by funding a substantial expense account for the employee. Just because particular clients are regarded as having a close connection with a particular individual broker does not mean that the broker is entitled to treat the client as his or her own."

Tips for drafting a non-compete clause

It is clear from the case law that there is no one answer as to what constitutes an acceptable restraint and whether a restraint will be held as valid by a court will depend on the circumstances of the individual case. However, the following general points can be ascertained in relation to non-compete clauses:

  • carefully consider the legitimate business interests you want to protect;
  • tailor any restraint to the circumstances applicable to the individual being restrained and avoid blindly using pro-forma templates – it is important to consider the position of the employee and what kinds of information they have had access to across the course of their employment. An onerous restraint will be more likely to be held reasonable the more senior the employee is.
  • remind any individual who is subject to a restraint of their obligations under it prior to them either leaving employment or otherwise no longer having involvement with the entity the restraint purports to protect.

In our next article we will take an in-depth look into non-solicitation or non-dealing clauses, which restrict an employee from soliciting their former employer’s clients or other employees of the business. 

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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 communication. Persons listed may not be admitted in all States and Territories.