The Effectiveness of Restraint Clauses
Posted on June 7, 2017 by Ashley DawsonWith increasing reliance on restraint clauses in employment contracts, understanding the enforceability of a restraint is imperative. At common law a restraint of trade clause will be enforceable where it is deemed reasonably necessary to protect the legitimate business interests of the employer. While ‘reasonableness’ is circumstantial, there is considerable case law to assist employers in ensuring the efficacy of a restraint of trade clause.
The Basic Principles Governing Restraints
Post-employment restraints will generally impose restrictions against competition, solicitation of clients, solicitation of employees, and the disclosure of confidential information. Establishing that the restriction is reasonable and in the interests of the parties will be determined by considering the circumstances at the date of the employment agreement. In general terms, factors that will be taken into consideration include:
- The nature of the business;
- The nature of the particular employee’s position; and
- Whether the employee has access to confidential information of the employer.
It is the person seeking to enforce the restraint- the employer, who bears the onus of proving that the restraint is reasonable. The protection conferred from a restraint must be no more than ‘adequate protection’. A restraint which exceeds the level of protection that is justified, will be unreasonable and void.
Unreasonable Restraints
In the recent case of Just Group Ltd v Peck[1], the CFO of clothing group, Just Group Limited (‘JGL’), informed her employer of her intention to commence employment as General Manager, Finance and Treasury for competitor, Cotton On Group Services Pty Ltd (‘Cotton On Group’). JGL subsequently commenced proceedings in the Supreme Court of Victoria for an injunction.
The restraint clause restricted the CFO from engaging in restricted activity- activity the same or similar to JGL, or activity on behalf of an entity provided in an annexure to the contract- in the geographical region, for a restricted period.
The Annexure contained a list of 50 entities, and included Cotton On Group. The geographical region and restricted period were defined as cascading provisions, and restrained the CFO from commencing employment with a restricted employer in Australia and New Zealand for a maximum period of up to 24 months.
JGL argued that the restraint was necessary to protect their confidential information, which was defined in the employment contract as “all information regarding the businesses of JGL”.
Justice Michael McDonald held that the restraint was unenforceable as it went further than what was considered reasonable to protect the legitimate interests of JGL. Justice McDonald held that the proper construction of the clause restrained the CFO “from engaging in any employment, including employment in a position in which confidential information obtained by her would be of no relevance to a new employer”.
Justice McDonald further held that the ranging period from 12 to 24 months were “unreasonable because of the disparity with the one-month notice period, or payment in lieu, upon which [the CFO’s] employment could have been terminated during the first six months of her employment”. In the circumstances this disparity was held to be relevant to determining the reasonableness of the restraint:
“…on the one hand, JGL reserved to itself the right to terminate [the CFO’s] employment on one month’s notice within a short period of her commencing employment. On the other hand, it reserved to itself the right to impose wide ranging restrictions upon her capacity to earn a livelihood for a period of 12 months”.
What is deemed ‘reasonable’?
In the case of Cactus Imaging Pty Limited v Glenn Peters [4] it was held that a restraint was enforceable as it was necessary to protect the confidential information of the employer. In this case a former sales manager commenced employment with a major competitor of the company.
The relevant restraint clause prevented the employee from disclosing any confidential information to other persons, carrying on, or engaging in, a business in competition with the company; soliciting clients; or poaching employees for twelve months after employment ended.
Justice Brereton held that the possession of confidential information would give the competitor a significant commercial advantage in winning work from the employer. The length of the restraint was deemed to be reasonable as it was held that the information would remain relevant during this time.
Similarly, in Birdanco Nominees Pty Ltd v Money [5] the Victorian Supreme Court of Appeal held that a restraint restricting a former employee of an accounting firm from providing accounting services to a client of the employer was valid. The restraint provided that for three years, the employee did not provided services to a client with whom he had provided services for during the three years prior to the termination of his employment. The court held that the restraint was reasonable on the basis that it protected a valid interest, being the trade connection and the goodwill of the company. In determining that the restraint was enforceable, the Court found that the employee had obtained a significant understanding of the clients bookkeeping procedures and financial affairs throughout his tenure with the company.
Drafting a Restraint Clause
Key considerations when drafting a restraint clause include:
- Ensure the restraint is tailored to the employee’s individual circumstances. The restricted activities should be related to the employee’s activities in their position with the employer. Furthermore, the restraint period should correspond with the employee’s position, seniority, knowledge and access to confidential information;
- Ensure your protected interests are legitimate;
- Ensure that the restrained period and geographical area are no more than ‘adequate protection’ of the business’ interests. The time and geographical parameters should not be aimed merely at protecting competition;
- Undertake a review of restraint provisions when reviewing or renewing employment contracts.
If you are considering putting restraint clauses either in your employment contracts or business sale contracts, please contact our office and we can facilitate the drafting of the clauses with one of the law firms in our referral network.