Globalisation and technology have contributed to increased market competition and businesses are more determined than ever to protect their goodwill, trade secrets and customer connections. Including restraint of trade clauses in employment contracts is one way to achieve this.
A restraint of trade clause attempts to prevent an employee from engaging in competitive activities which may adversely affect the business. The restrictions apply during and after the employment relationship. However, it is generally not until the employee sources work with a rival company, or starts his or her own like venture, that enforceability of the restraint becomes an issue.
The general law considers restraint of trade clauses unenforceable unless they are reasonable and necessary to protect the legitimate interests of the employer’s business. In recognition that people should be free to apply their skills in pursuing a livelihood, restraints that do not meet the test of reasonableness will be struck out by the Courts.
Employers wishing to have restraint provisions upheld should ensure employment contracts are prepared by a competent commercial lawyer.
How is a restraint clause considered by the Court?
Restraint clauses generally prohibit the use of confidential and trade information and restrict the types of enterprises for whom a departing employee works. The restrictions apply for a specified duration of time and within a certain geographic location.
New South Wales is the only jurisdiction in Australia with legislation relating to the interpretation and validity of a restraint clause. The Restraints of Trade Act 1976 provides that restraint clauses are valid to the extent only that they are not against public policy. The Act enables a Court to read down a restrictive provision or to ‘re-write’ an offending restraint clause as it thinks fit.
In other States and Territories, the general law applies, which requires an unreasonable restraint to be struck out if it cannot be read down – the Court cannot re-write the restraint clause to make it reasonable.
To avoid these consequences, ‘cascading’ (alternative) restraint provisions are used in employment contracts. Should a restraint be successfully challenged as unreasonable, the Court can delete the undesirable clause and adopt an alternative, less restrictive one.
The employment contract often includes an agreement between the parties that, if one restraint term is considered unreasonable then an alternative reasonable clause may instead be upheld.
The risk of poorly-drafted or onerous restraint clauses
If a dispute regarding a restraint clause proceeds to Court, an employer has the onus of proving the clause is reasonable and necessary to protect its interests. Employment contracts that do not include reasonable or alternative provisions may fail, causing the entire restraint to be ineffective. Such was the case of Just Group Limited (JGL) v Cotton on Group Services Pty Ltd (Cotton On), recently heard in the Victorian Supreme Court.
An employment contract contained broad restraint provisions that attempted to prevent an ex-employee of JGL from working in any capacity with any of 50 of JGL’s competitors, or their related entities for either 12 or 24 months.
Although the Court accepted that the ex-employee was privy to commercially sensitive information during the term of employment, the restraint provisions were considered far too wide to be reasonable and necessary to protect the interests of JGL.
Unfortunately for JGL, the Court was unable to re-write or read down the offending clauses to make the restraint reasonable. Further, although alternative provisions were included regarding a lesser duration for the restraint, the breadth of restrictions placed on the employee’s activities was still considered unreasonable. The attempted restraint failed completely.
The Court considered that, had the contract only restricted the employee’s future employment with Cotton On (a known rival competitor of JGL), then those restrictions may have been enforceable.
What are the legitimate interests of the business?
An employee has a fiduciary duty of confidentiality and good faith to the employer and the employer has a right to ensure that company information is not misused or wrongfully disclosed. Confidential information does not comprise information that is freely available to the public such as the mere contact details of clients. However, customer connections will likely be protected. The Court will also consider anti-poaching clauses and clauses protecting trade secrets as reasonable.
A reasonable restraint clause must only go so far as to protect the legitimate interests of the employer. A blanket no-compete clause will fail as will trying to cast a net over a myriad of possibilities regarding the future activities of the employee.
Whilst each matter will turn on its merits, cases such as Just Group Limited v Cotton on Group Services Pty Ltd reiterate the importance of well-structured employment contracts. A restraint clause that is not deemed fair in the eyes of the Court will fail.
Employment contracts should contain reasonable restraints and alternative clauses. If faced with the issue of unreasonableness, a Court may then severe the impugned term whilst allowing a less-restrictive reasonable clause to stand.