NSW Court of Appeal Declines to Enforce Restraint of Trade against Vendor in Transaction Agreement

From both an employment and an M&A law perspective, the decision is particularly intriguing considering the weight given by the Court of Appeal to the “disconformity” between the restraints of trade contained in the transaction agreement and those contained in the employment agreement between the parties.

The decision highlights a number of considerations which, from the purchaser’s perspective, will need to be given closer consideration when negotiating and drafting not only the restraint of trade clauses in the transaction agreement, but also when negotiating the terms of employment to be offered to vendors post-completion.

Background

Sable37 was a Microsoft software solutions business owned by Sable Systems Pty Ltd, as trustee for the Sable Systems Unit Trust. The Second Respondent, On‐Key Consulting Pty Ltd (OKC), held one third of the units in the Sable Systems Trust.

In April 2018, DXC Eclipse acquired Sable37 by way of a Securities Purchase Agreement (SPA) entered into with several vendors, including Mr Wildsmith and OKC. At the time, Mr Wildsmith was the “Global Managing Director” of Sable37. He was also the owner and controller of OKC.

The SPA imposed both non‐competition and non‐solicitation restraints on the vendors including on Mr Wildsmith and OKC. These restraints were to operate for a maximum period of 7 years from the “Completion Date” of 4 April 2018.

The SPA also required that Mr Wildsmith serve as DXC Eclipse’s “ANZ Director — Microsoft” for at least one year. Mr Wildsmith’s employment with DXC Eclipse was governed by an employment agreement dated 27 March 2018 (Employment Agreement) which not only documented this one-year minimum term, but also imposed a six-month non‐competition restraint upon Mr Wildsmith.

Mr Wildsmith continued in this position well beyond this one-year minimum, until his resignation in July 2021. In December 2021, Mr Wildsmith incorporated a new software solutions business called Will Thirty Three Pty Ltd (Will Thirty Three), with the major shareholder being OKC. By this time, a period of three and a half years had passed since the “Completion Date”.

DXC Eclipse commenced proceedings in the NSW Supreme Court seeking injunctive relief against Mr Wildsmith and OKC on the basis that the business of Will Thirty Three breached the non‐competition and non‐solicitation restraints in the SPA. Notably, the non-competition restraint contained in Mr Wildsmith’s employment agreement had by that time expired.

At the first instance, Justice Parker found that the restraints were unreasonable in scope, dismissing DXC Eclipse’s claim and discharging the interlocutory orders that had been made against Mr Wildsmith. DXC appealed this decision.

Appeal Decision

The NSW Court of Appeal upheld the decision of Justice Parker, dismissing DXC’s appeal and again finding that the 7-year duration of the restraints in the SPA were unreasonable in the circumstances.

In reaching this decision, the Court of Appeal determined that the level of competition between Sable37 and Will Thirty Three was minimal, particularly as the Respondents were not selling or threatening to sell similar products to DXC Eclipse “so as to compete with it seriously” or which might “pose a real commercial threat” to DXC Eclipse. It was noted that not only would protection against de minimis competition be unreasonable, but also that the legitimate protection of the purchase of the goodwill of a business does not require protection against such competition.

DXC Eclipse submitted that the SPA included language expressly acknowledging the reasonableness of the restraints contained therein. It has long been understood that clauses to this effect contained in an SPA carry significant weight (more so than in the employment context). Indeed, the Court of Appeal acknowledged that in the area of M&A transactions, there are statements in the authorities that recognise the importance of holding parties to their bargains. However, it was noted that even in this context, “such a consideration will not be determinative nor is it capable of providing a finding of reasonableness.”

Employment Agreement

It was debated whether an assessment of the reasonableness of the non‐competition restraint in the SPA could be affected by the far shorter restraint period under the Employment Agreement.

DXC Eclipse rejected this submission on the basis that the restraint in the Employment Agreement sought to protect different interests to those contained in the SPA. It was argued that the restraints in the Employment Agreement sought to protect DXC Eclipse in relation to any confidential information and customer connection that Mr Wildsmith acquired whilst in its employ, whereas the restraints in the SPA sought to protect DXC Eclipse’s acquisition of the goodwill of the Sable37 business.

While the Court of Appeal accepted this distinction, Chief Justice Bell was not of the view that the “disconformity” between the restraints contained in Mr Wildsmith’s employment agreement and the restraints contained in the SPA was “wholly irrelevant”, reminding the parties that:

“Although the reasonableness of any restraint is to be assessed as at the time at which the relevant contract has been entered into, the discretion whether to enforce any restraint may be informed by considerations at the time enforcement is sought…”

The Court of Appeal drew the parties’ attention to the time that had elapsed since the parties had entered into the SPA, and it was noted that no evidence had been led, nor had any explanation been given to as to how or why DXC Eclipse would be deprived of the benefit of the goodwill it had acquired so long ago. The Court of Appeal found this to be especially notable considering that DXC Eclipse’s ability to realise the benefit of the goodwill was greatly enhanced by the fact that Mr Wildsmith had remained employed well-beyond the one-year minimum term under the Employment Agreement. Given that Mr Wildsmith was only contractually required to remain with DXC Eclipse for one year was seen as giving some insight into how long DXC Eclipse needed to realise the goodwill it had acquired.

The Consequences

Purchasers will need to closely consider the terms of employment offered to vendors post-completion and will need to be conscious of the risk of these terms later being used to assess the reasonableness of restraints of trade imposed upon the vendors under the relevant transaction agreement. Particular attention will be needed where the vendors only agree to continue to work in the business for a short-period of time post-completion, which is not uncommon. In most cases, consistency in the restraints included in the employment agreements and the transaction agreement will be the safest course of action.