You might be in retail, in professional services, manufacturing or in the construction industry, either way, it is an inevitable fact that as your business grows and expands, you will be employing or contracting with people who will gain intimate knowledge of your business operations and in many cases they will form valuable relationships with your customers and suppliers.

Competition is a fact of life. It can often produce harsh results for those who are on the ‘losing side’. However, there are steps you can take to limit the effects of competition, one of them being a restraint of trade clause.

What is a restraint of trade clause?

A restraint of trade clause is a provision found in a variety of contracts such as employment agreements, consulting agreements, franchise agreements, sale of business agreements, shareholders’ agreements and so on.

A restraint of trade clause is a mechanism that prohibits the restrained person from competing with you (non-competition), enticing your customers and employees away from you (non-solicitation) or other prohibitions that may be specific to your business.

A restraint of trade clause will also usually have a number of alternative duration periods (for example, 12 months, alternatively 6 months, alternatively 3 months) and alternative geographical application (for example, within Australia, alternatively, the eastern seaboard States, alternatively Victoria). These provisions are known as ‘cascading’, ‘waterfall’ or ‘ladder’ provisions.

There is no end to the permutations and combinations that are used in restraint of trade clauses. They are drafted this way in an effort to protect some version of the restraint if there is a legal challenge to the clause.

What does the law say?

Given that the law is pro-competition, it will come as no surprise that the starting point is that a restraint of trade clause will be unenforceable unless you can show it is reasonable both in the interests of the parties and the public.

Whether a restraint of trade clause is valid is to be determined as at the date of the relevant agreement. The Courts also appear to take a stricter view of restraints in employment agreements than other agreements.

What have the Courts Said?

In Sportsbet Pty Ltd v Carpanini,1 the Victorian Supreme Court refused to grant a restraining order against a former employee who was defecting to a business competitor because the restraint clause that prevented the employee from working or interacting, in any capacity, anywhere in Australia, with any competitor of her former employer for 6 months, was unreasonable.

It was clearly too broad in its scope for this particular employee, who was not a senior company executive possessed with crucial confidential information.

In the case of BearingPoint Australia Pty Ltd v. Hillard,2 the Supreme Court of Victoria regarded as unreasonable a restraint period of 12 months which followed a notice period of 6 months. Operating in tandem with the notice period for a cumulative total of 18 months, the restraint period was regarded as too broad and unreasonable, and extended beyond what was necessary to protect the employer’s legitimate business interests. The Court consequently ordered that the entire restraint clause be severed from the employment agreement, leaving the employer with no right of restraint over the ex-employee.

In the recent case of BDO Group Holdings (Qld) Limited & Anor v Scully,3 the Supreme Court of Queensland considered restraint of trade provisions in which the legitimate interest sought to be protected was the goodwill and the relationships developed between the employer and its customers. The ex-employee’s shareholders agreement and employment contract had a typical cascading restraint period starting from 18 months and a cascading restraint area starting with Queensland, New South Wales and Victoria. However, the Court regarded a period of only 12 months to be a reasonable length of time for an employee appointed to replace the ex-employee to form relationships and maintain existing goodwill with BDO’s customers, and accordingly the restraint period was reduced to 12 months. The Court did not strike down the widest geographical reach of the clause (which was Queensland, New South Wales and Victoria) although BDO only sought to defend a geographical reach of Queensland and New South Wales.

In another case of Cactus Imaging Pty Ltd v Peters,4 the Supreme Court of New South Wales granted an injunction restraining an ex-employee from soliciting clients and employees for a period of 12 months following a notice period of 4 weeks, which was viewed as reasonably sufficient to protect the employer’s legitimate interest in protecting its goodwill in the business.

Take Home Messages

In formulating a restraint of trade clause or reviewing an existing one, you should consider the following:

1. There is a delicate balance between a natural desire to protect your business interests and at the same time ensuring that you do not overstep the mark when trying to prevent someone from doing things that do not actually damage your business.
2. You must take care to insert a carefully drafted, fair and reasonable restraint of trade clause only to the extent necessary to protect your legitimate business interests. A badly drafted, excessively broad or unreasonable restraint provision is more than likely to lead to no protection at all.

Recommendations

In determining whether a restraint of trade clause is fair and reasonable, we recommend you take into account the following issues:

1. Is the period of restraint reasonable and not greater than necessary to protect your legitimate business interests?
2. Does the restraint take into account the length of the notice period?

1. Is the restraint specific to particular activities which are within the person’s ambit of activities?
2. Is the restraint specific to a reasonable geographical area which the business operates in?
3. Is the restraint limited to specific customers and/or suppliers of the business which the person is reasonably expected to have had contact with?

How Can We Help?

Our business law team is very experienced in drafting and advising on restraint of trade clauses and on the agreements in which they are found.

Please contact us if you have questions about an existing restraint clause or wish to know more about this important business issue.

Philip Earle, Partner

Ashley Ngion, Lawyer (English & 中文)