It is common for employers to include post-employment restraint clauses in their employment agreements, in an attempt to protect their confidential information, client base and staff from departing employees.
These restraint clauses are increasingly becoming a standard term in most employers’ template employment agreements, but what is commonly overlooked is the relatively limited circumstances in which these restraints will be enforced against employees.
The purpose of this Insight is to provide an overview of the legal principles underpinning post-employment restraint clauses, and the circumstances in which such restraints are likely to be held to be enforceable.
The Usual Restraints: Competition and Solicitation
Restraint of trade clauses come in a variety of different shapes and forms, depending on the nature of the contractual relationship between the parties.
In the employment context, the two main types of restraint clauses are non-competition restraints and non-solicitation restraints.
Non-competition restraints seek to prevent departing employees from engaging in businesses or activities in competition with their former employer.
Non-solicitation restraints seek to prevent departing employees from soliciting or dealing with the customers, clients, suppliers, employees, and contractors of their former employer.
Enforceability: The Starting Point
At common law in Australia, there is a presumption that post-employment restraint clauses are contrary to public policy and are therefore void and unenforceable. To rebut this presumption, an employer needs to establish that the particular restraint:
- Serves to protect a “legitimate business interest” of the employer; and
- Is reasonably necessary to protect that “legitimate business interest”.
At a technical level, it is not strictly correct to say that post-employment restraints are prima facie void and unenforceable in New South Wales, given the operation of the Restraints of Trade Act 1976 (NSW). This legislation renders restraint of trade clauses valid to the extent to which the restraint is not against public policy. It follows that practically speaking, there is little difference between the requirements for a restraint to be deemed valid and enforceable under the Restraints of Trade Act 1976 (NSW) as compared to the requirements under the common law.
However, what distinguishes NSW from other Australian jurisdictions is that under this legislation, a judge has broad powers to read down the restraint clauses so that they are enforceable (e.g., by reducing the length of the particular restraint or the area of the particular restraint, so that it reflects what is reasonably required to protect the relevant “legitimate business interest” of the employer). In saying this, the legislation does not allow the judge to remake the contract or the relevant restraint clause in the contract. While a judge is permitted to read down the clause if the clause is so capable, the clause cannot be re-drafted by the judge.
The “Legitimate Business Interests”
Courts are generally reluctant to uphold post-employment restraint clauses where the restraints are for the sole purpose of prohibiting a departing employee from setting up or being involved with a competing business. Competition alone is not a “legitimate business interest” of an employer.
Instead, the “legitimate business interests” which employers tend to seek to protect through restraint clauses are their confidential information, their clients, customers and their “goodwill”, and their staff.
Of these three broad categories, the main “business interest” which employers tend to have success relying upon is the protection of their client and customer base and their “goodwill”. Cases have established that these are interests which can support a reasonable post-employment restraint, but only if the employee has become the “human face of the business” – that is, the person who represents the business to the client or customer.
Courts look at the relevant knowledge of the employee in question and consider whether that knowledge is more than simply the skill and understanding necessary to equip the employee as a possible competitor of the employer. Rather, the employee must have obtained personal knowledge of and influence over the clients and customers of the employer or developed such an acquaintance with the employer’s trade secrets as would enable the employee to take advantage of the employer’s trade connections or to utilise information confidentially obtained.
With respect to this confidential information of the employer, cases have also established that an employer is entitled to protection against the use by a departing employee of knowledge obtained of the employer’s affairs in the ordinary course of trade. However, there will be instances where an employer will have a better chance at protecting its confidential information by seeking to enforce the confidential information obligations included in the relevant employment contract and which exist at common law and in statute, rather than by attempting to enforce a restraint against the employee.
The Question of Reasonableness
If the court is satisfied that a particular post-employment restraint is necessary to protect a “legitimate business interest” of the employer, it must then be determined whether the restraint is reasonably necessary to protect that interest.
In determining this question of reasonableness, the courts primarily have regard to:
- The precise activities which are sought to be restrained;
- The duration and area of the restraint;
- The position and seniority of the employee; and
- The nature of the employer’s industry and the value of personal relationships in that industry.
Although this question of reasonableness is assessed at the time when both parties agreed to the restraint (i.e., at the time of entering into the employment agreement), consideration is also given to potential developments in the employee’s position during the course of the employee’s employment.
It is clear from the above that the question of whether a particular post-employment restraint is enforceable will depend on the facts and circumstances of the individual case. However, there are steps that employers can take to improve the chances of the restraints in their employment agreements being held to be enforceable. These include:
- Avoiding blindly using standard or “pro-forma” post-termination restraint clauses. Employers should carefully consider what interests they wish to protect and what would be a reasonable restraint period and area for the employee in question, and the restraint clause should be drafted on this basis. In this respect, it is generally recommended that employers use cascading definitions for the restraint period and area, if appropriate.
- Avoiding ambiguity and instead, being clear and specific as to the activities to be restrained. Courts are unlikely to uphold broad and vague restraint of trade clauses.
- Ensuring that the employment agreement includes an acknowledgment by the employee as to the necessity of the restraints and the reasonableness of the restraints. Courts give considerable weight to what parties have negotiated and embodied in their written agreements (although a contractual consensus cannot be regarded as conclusive, even where there is a contractual admission as to reasonableness).
- Giving consideration to the governing law of the employment agreement and in what court proceedings are commenced by the employer so as to have the benefit of the Restraints of Trade Act 1976 (NSW).