31 Mar 2022

Restraints of trade in the employment context 01: What do I need to know?

By Jennifer Wyborn, Nicholas West-Foy and Sarah Pain

Restraint of trade clauses can be enforceable if they satisfy two tests.

In our first article in this series, we take a first principles look at restraints of trade and when and in what circumstances such restraints may be enforced.

Back to basics: An overview of restraints of trade

Post-employment restraint of trade clauses are often found in business sales and employment agreements. Their core function is to seek to restrain a party from doing something.

In the employment context, there are typically two main types of restraint clauses, being:

  • Non-competition clauses, which seek to prevent employees from competing with their former employer after their employment with that employer ends; and
  • Non-solicit or non-dealing clauses, which seek to prevent:
    • former employees from soliciting or dealing with clients for a set period of after the cessation of their employment; and/or
    • soliciting other employees to leave the business of the former employer for a set period of after the cessation of their employment.

Restraint of trade clauses are also often used alongside clauses preventing the use or misuse of confidential information. Confidential information can include things like client lists and contact details of those clients, as well as trade secrets, where this information has been obtained during the course of the employee's employment.

The starting presumption is that restraint of trade clauses are unenforceable, as they are considered to be contrary to public policy. However, at common law, restraint of trade clauses can be enforceable where:

  • an employer has a "legitimate protectable interest" (First Limb); and
  • the restraint of trade clause is "no more than reasonable" for the protection of that legitimate interest (Second Limb).

First Limb: What are "legitimate protectable interests"?

In an employment law context, the categories of protectable interests generally refer to the legitimate protectable interests of the employer, including their interest in:

  • customer connections and "goodwill";
  • trade secrets or confidential information; or
  • retaining current employees of the company.

The onus will be on the party seeking to protect their interest to demonstrate the restraint is reasonable in the circumstances. This will often involve demonstrating that the party that the person is seeking to restrain has:

  • relevant knowledge, which must be more than mere personal skills and knowledge, to equip them as a competitor; or
  • was the "human face of the business", such that they have influence over and can take "customer connections"; or
  • that they have solicited (understood as having asked or called for) clients or other employee's to leave the business.

The Second Limb: What is reasonable?

For a restraint to be enforceable, it must be tightly drafted, and be no more than is reasonably necessary to protect a legitimate interest.

In considering the reasonableness of a restraint, a range of factors may be assessed, including:

  • the restraint's duration, being how long the restraint seeks to prevent certain conduct;
  • the geographical area in which the restraint is to have effect;
  • the activities the restraint seeks to restrain;
  • the nature of the industry and value of personal relationships in that industry;
  • the employee's seniority, business connections and the extent to which an employee was the "face of the business"; and
  • whether the employee possesses confidential information, and if so, the nature of that information.

By way of example, a non-solicitation clause which sought to prevent an individual from soliciting any and all clients of the business, for an indefinite period of time, would likely be unreasonable. However, a clause that is limited to only the clients the individual had interactions with, within a set period, and where the duration of the restraint is limited, the more likely it is that the restraint will be considered reasonable to protect a legitimate business interest. The extent to which a restraint will prevent an individual from obtaining work will also likely be persuasive in determining the reasonableness of a clause.

This was the case in Just Group Limited v Peck (2016) 264 IR 425. In this case, Ms Peck was employed as a CFO at Just Group from January 2016 until her resignation in May 2016, where she took up a position at a competitor. Just Group sought to enforce the restraint clauses contained in Ms Peck's employment contract, including several provisions which purportedly prevented Ms Peck from working with 50 retailers (including the employer she had just commenced working with) anywhere in Australia and New Zealand for a period of 12 to 24 months.

In ruling the restraint unenforceable, the Court determined that its various permutations were excessive and led to ambiguity. The Victorian Supreme Court found that the restraint clause prevented Ms Peck from engaging in any activity that was "the same as, or similar to" the work she undertook, and would unreasonably preclude her from working with entities where the confidential information she had obtained during her employment was irrelevant.

What if it is not reasonable?

Where a court determines the scope of a particular clause is unreasonable, it will often consider if the unreasonable parts of a restraint clause can be "severed" in a way that allows the reasonable aspects of the clause to still be applied. At common law, courts in jurisdictions other than NSW apply what is called the "blue pencil test". What this means is that the court will assess whether discrete portions of a restraint clause that it considers unreasonable can be run through with the "blue pencil" and removed, whilst still retaining the remainder of the otherwise reasonable clause, such that it can still be applied.

The blue pencil test will only allow for a portion of the restraint being severed where doing so would not alter the nature of the contract or modify the words in any way other than by exclusion. It is the inability to sever "without altering the nature of the contract" portion of the test where most cases fail. The ability to sever parts of a restraint clause is why it is common to see "cascading" clauses in a restraint. This will often frame restraints in descending ("cascading") restraints that apply to different geographical areas or time periods, such as being enforceable for either 12 months, 6 months or 3 months. However, such cascading clauses should still be used with caution, and where too many variations are provided, a court can find the clause void for uncertainty. This was the case in Austra Tanks Pty Ltd v Running (1983) 40 ATPR 340, where the Court found a clause that contained 82,152 variations on the restraint, was unenforceable.

The situation is slightly different in NSW. In this jurisdiction, under the NSW Restraint of Trade Act 1976, courts do not need to resort to the "blue pencil" test. Instead, courts are able to "read down" restraints to limit duration or area, without needing to actively "sever" parts of the clause. Practically, this means restraints are more likely to be enforceable in NSW, compared to other Australian jurisdiction, provided of course that the presumption that they are unenforceable and against public policy is overcome.

What action can you take and what are the consequences of a breach?

At a high level, only a court can assess with finality the enforceability of a particular restraint in the particular circumstances. However, where a restraint that is objectively reasonable is not complied with, there are a number of options available to take action, depending on the nature of the restraint and consequences of the apparent breach.

In some cases, simply writing to the other side and requesting they enter into an undertaking may resolve the issue. It is useful to note that the Corporations Act 2001 (Cth) also contains prohibitions against the improper use of confidential information, and that this may also be relied upon where appropriate to strengthen action taken when seeking to enforce a restraint. In more complex or adversarial matters, a party may commence court proceedings for breach of contract and/or fiduciary duties. This may include applying to court for compensation or injunctive relief. Another option is to enter into consent orders prior to progressing to a hearing, or reach an out-of-court settlement at mediation.

In any case, we recommend seeking legal advice at the earliest opportunity in order to resolve an apparent breach of a restraints.

In our next article we will take an in-depth look into non-compete clauses, and some of the ins-and-outs of enforcing this type of post-employment restraint of trade.

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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.