Restraints in Employment Agreements

Restraint EMployment ContractsBy Rodney Commins and Lachlan Commins, Patterson Houen & Commins, Lawyers, Sydney.

Protect your business & know your rights

Employers have a legitimate interest in protecting their confidential or commercially sensitive information not in the public domain. Confidentiality obligations are often specified in the employment contract but even if they are not they will be implied as a matter of law. Often however employers will wish to go further and impose post-employment competition restraints especially on employees who have been in a position to establish close relationships with the employer’s customers.

How can an employer do this effectively? Consider this as the following is a typical example of a post-employment restraint:

In consideration of employment by Superco, Marvel covenants with Superco that if for any reason he/she ceases to be employed by Superco he/she will not at any time within the area of, for example, Australia and New Zealand during the period of three (3) years after ceasing employment with Superco, be either directly or indirectly engaged in the provision of products or services similar to the products or services of Superco to customers of Superco existing at the time he/she ceases to be employed by Superco, without the express approval of Superco, which shall not be unreasonably withheld.

The interpretation, scope and effect of such a clause is subject both to the ‘restraint of trade doctrine’ and in NSW the Restraint of Trade Act 1976 (NSW).

The Doctrine

By virtue of the restraint of trade doctrine, the following general principles apply to all postemployment restraints:

i. All such restraints are prima facie void (that is invalid and unenforceable); however
ii. A restraint may be enforceable if it satisfies the following three conditions:

  • The effect of the restraint seeks to protect a ‘legitimate interest’ of one or both of the parties; AND
  • The scope of the restraint affords no more than adequate protection to the party seeking to uphold the restraint (that is, the restraint must be reasonable and not excessive as a means of protecting the interest); AND
  • The terms and effect of the restraint are not injurious to the public interests; and

iii. The onus of establishing the first two conditions rests on the party seeking to uphold
and enforce the restraint, while the onus in respect of condition 3 is with the party
seeking to avoid the restraint.

Accordingly, if Superco were to act to enforce the restraint clause against Marvel, it would need to persuade the court that the particular restraint:

  • Seeks to protect a legitimate interest of Superco;
  • Is reasonable and not excessive in seeking to protect this interest; and
  • Is not injurious to the public interest (note however the onus shift referred to above).

There are three aspects of an employment restraint clause. They are:

  • The restricted area;
  • Its duration; and
  • The activities restrained.

A reasonable measure of protection of the employer’s legitimate interests must be balanced against the right of the former employee to have the opportunity to obtain gainful employment (“Rentokill Pty Ltd v Lee”).

Legitimate interest?

Superco will claim that the restraint clause seeks to protect its legitimate commercial interest being the protection and conservation of its commercial ‘goodwill’. As an asset capable of being valued and assigned, Superco will claim to hold the exclusive proprietary interest in the business’s ‘goodwill’ and thereby be entitled – through the enforcement of the restraint clause – to have it protected and preserved.

In this case, the ‘goodwill’ entitled to protection will be the professional relationships which Marvel (may) have established with Superco’s customers whilst employed by it. The inherent value in these relationships (if any) to Superco’s business will be said to form part of its
protectable goodwill.

If Superco’s arguments find favour, Marvel may be restrained from acting in any new role with a competitor organisation in a way that undermines or derogates from Superco’s goodwill. For instance, Marvel could be restrained from drawing on, utilising or exploiting the professional relationships (if any) that he/she had established whilst employed by Superco. This is because the goodwill which Marvel may have helped to create at Superco remains the property of Superco even though Marvel is no longer employed with the company.

Such an outcome would be dependent on Mervel’s role with Superco involving the establishment and fostering of close and dependable professional client relationships to the extent that such clients would consider Marvel to be their ‘go-to-person’ at Superco or otherwise as their ‘link’ to the company. That is, such clients would consider the services and skills Marvel provided as unique and distinguishable from the services otherwise provided by other employees at Superco.

Reasonable and not excessive?

The example restraint clause in its current form consists of four essential elements:

  1. Restrained Activities being the provision of goods and services similar to or competitive with those supplied by Superco;
  2. Restrained Clients being clients who were clients of Superco at the effective date of termination of Marvel’s employment with Superco;
  3. Restrained Period being three years from the effective date of termination of Marvel’s employment with Superco;
  4. Restrained Area being Australian and New Zealand.

As the restraint clause stands Superco would need to prove the reasonableness and proportionality of each and every one of the restrained elements as at the time the restraint was imposed (usually in the employment agreement) and not at the time the restraint is sought to be enforced.

It is critical to remember that Superco cannot validly restrain Marvel from earning a living or even from competing with it by providing services to a competitor organisation once Marvel’s employment with Superco has ended. Superco does, however, have a right to protect and maintain its goodwill, which is a valuable asset of the company and in which it has a proprietary interest. To this extent, any enforceable post-employment restraint must be no wider than is necessary to protect the Superco goodwill (that is reasonable and proportionate). Accordingly, three years (absent any special influence which Marvel may have had in his/her employment) may well be an unreasonable and excessive period of time with respect to which Superco can legitimately claim as necessary to protect its goodwill.

It would be prudent therefore to draft the restraint clause to carefully define the restraint activities and to include cascading time limits and geographical areas.

Injurious to the public?

Even if the restraint is found to be reasonable between the parties (Superco and Marvel) it is then necessary to consider whether or not the restraint is otherwise injurious to the public interest. At this point, the onus of proving that the restraint is unreasonable as being against public policy shifts to the party (Marvel) seeking to strike down the restraint. In general “public interest” is the reasonable availability of the services of the employee and freedom of trade.

In practice, very few restraints have failed on this ground alone.

The Restraint of Trade Act 1976 (NSW) (“the Act”)

In NSW the court has power to strike down restraints under the Restraints of Trade Act and to effectively ‘re-interpret’ or modify the restraint so that its terms, scope and effect do not offend the restraint of trade doctrine. This is because the Act gives the court the power to hold a particular restraint valid to the extent to which it is not against the public interest.

In this example, the NSW court could by re-interpretation validate a shorter Restraint Period, depending on the strength of the professional customer relations which Marvel had established with Superco clients and Marvel’s perceived or actual ability to draw upon the strength of such relationships in his/her new role with a competitor organisation. The actual period would be limited by the objectively determined reasonable period enabling Superco to retrieve ‘shore-up’ and consolidate the goodwill created by the customer relationships which Marvel had enjoyed whilst at Superco; any period longer than this would simply be an invalid fetter on Marvel’s liberty to earn a living in his/her chosen calling.

Take out points

  1. An employer is entitled to enforce a reasonable and proportionate post-employment restraint in order to protect its legitimate commercial interest. Don’t get too greedy.
  2. In NSW, the court has power to ‘re-interpret’ the otherwise invalid restraint so that its terms, scope and effect do not offend the restraint of trade doctrine.
  3. There is no “one size fits all” restraint. To be enforceable the facts and circumstances of each employment relationship must be taken into account and the clause “customised” accordingly. Therefore beware of pro-forma or standard form restraints.
1 Rentokill Pty Ltd v Lee (1995) 66SASR 301

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