A restraint of trade clause is a term in a contract that limits a person’s ability to compete, work for a competitor, use information and solicit staff and clients for a period of time. A restraint of trade clause may appear in an employment contract, deed of release, business sale agreement or a contractor’s agreement.
In this article, we’ll take a look at restraint of trade clauses, explain what they are and how they operate from a commercial and legal perspective.
Author: Farrah Motley, a Solicitor of the Supreme Court of Queensland.
What is a Restraint of Trade Clause?
A restraint of trade clause does just that; it restrains the person agreeing to it from doing something in relation to trade (including employment) for a certain period of time. Restraint clauses are also generally limited to a particular location (for instance, a suburb, city or country).
Restraint of trade clauses can take a number of different forms, including:
- Non-compete clauses that prevent a person from creating or joining a business which competes their former employer (or, in the case of a contractor, their client) for a certain period of time.
- Non-solicitation clauses that prevent a person from soliciting their former employer’s clients for a certain period of time.
- Non-recruitment clauses that prevent a person from approaching (also called ‘soliciting’ or ‘enticing’) a company’s employees and encouraging them to leave that company and join another business.
- Confidentiality clauses that prevent the use by a person of a former employer’s confidential information.
A Restraint of Trade Clause Must Protect Legitimate Business Interests
In an employment context, a restraint of trade clause that goes beyond what is reasonably necessary to protect a business’s genuine business interests may be unenforceable. In other words, it won’t be worth the paper it’s written on.
A legitimate business interest may include things like protecting confidential information, retaining your existing employees and having sole and exclusive use of client and customer lists.
Seeking to ensure that a former employee does not compete against a former employer may not be considered a legitimate business interest that requires protecting.
Generally, courts are more willing to enforce restraint of trade clauses that relate to the reputation and goodwill regarding the sale of a business, than they do for those trying to limit the post-employment activities of an individual. This is because there is almost always an imbalance in the bargaining power between an employer and employee (meaning the employee has little power to negotiate).
On the other hand, there is a more equal playing field between a seller and purchaser of a business and a restraint of trade is typically paid for by a purchaser.
A restraint of trade clause should identify the interest that the business is trying to protect.
A Restraint of Trade Clause is Limited to a Time Period
A restraint of trade clause cannot last forever. In fact, any obligation in a contract that claims to go on forever may be unenforceable. If a restraint of trade clause is not limited by a finite period of time, it is unenforceable.
Now we’ve established that a restraint of trade clause must be limited to a particular period of time. To ensure that a restraint of trade clause is (as much as possible) enforceable, it should be written so that there is not just a period of time, but a cascading period of time.
An example of a cascading time period in a restraint of trade clause is set out below:
Restraint Period means:
(a) 1 year;
(b) 9 months;
(c) 6 months;
(d) 3 months; or
(e) 1 month.
These cascading time clauses will then usually be accompanied by an interpretation clause which explains that if the longer period of time is held to be unenforceable, the next time frame will apply – and so on.
As an example, let’s say Joe Bloggs has the above clause in his employment contract. He will be prohibited (by the contract) from doing whatever the restraint clause claims to prohibit for 1 year. If a court were to find that (in the circumstances – taking into account John’s role, employment prospects, competitors and location), 1 year was too long to be enforceable, it would then consider if 9 months was also too long. It would keep going until it got to a period of time it considered reasonable.
A Restraint of Trade Clause is Limited to a Location
Just as a restraint of trade clause cannot last forever, it cannot apply to an unreasonably large geographical location. Again, and to promote the enforceability of a restraint of trade clause, the location it applies to should be cascading in terms of geographical size.
An example of a cascading location in a restraint of trade clause is set out below:
Restraint Area means:
(a) the world;
(c) New South Wales;
(d) Sydney; or
(e) Sydney CBD.
Let’s say Joe Bloggs’s employment contract also contains the above as part of the restraint clause. Again, if a court were to find that prohibiting Joe Bloggs from doing the prohibited ‘thing’ anywhere in the world is too broad, then it would consider whether Australia is too broad, and so on.
A Restraint of Trade Clause Must not go Against Public Policy
Some Australian States and Territories have enacted legislation that prohibits restraints of trade which go against public policy. For example, the Restraints of Trade Act 1976 (NSW) states that restraints of trade (including those in a contract) are only valid to the extent they are not contrary to a public policy about restraints of trade.
Is Your Restraint of Trade Clause Reasonable?
If your executive employment agreement contains a restraint of trade clause, it will only be enforceable if it is reasonable and reasonably necessary to protect a business’s legitimate interests.
Restraint of trade clauses are difficult and expensive to enforce because:
- they impact a person’s ability to earn money;
- they may go beyond what is reasonably necessary to protect a company’s legitimate business interests;
- they can take time to challenge and, by the time the enforcement process is resolved, they have expired.
Restraint clauses are only enforceable to the extent that they are ‘reasonably necessary’ to protect the legitimate interests of a business. Whether a provision is enforceable will depend on the wording of the clause and the facts and circumstances of each case.
If a court finds that the restraint goes beyond providing a business with adequate protection of its interests, the court may decline to enforce the clause.
However, if the clause does not go beyond providing the business with adequate protection, the court will then consider whether the restraint of trade clause is harmful to the public interest. If it is not harmful to the public interest, the court is more likely to hold the restraint of trade clause as being valid.
The onus is on the party wanting to enforce the restraint of trade (usually the employer/company/client) must demonstrate that the clause is reasonable.
You can read more about restraint of trade clauses here.
How can Prosper Law help?
We know how restraint of trade clauses work, how to enforce them, when to let sleeping dogs lie and alternative strategies to protect your business. We have an intimate knowledge of Australian employment law and how businesses can make the most of their employment contracts.
Contact us today for a free, no-obligation, fixed fee quote.
Want to read more? Check out this article which explains how to read a contract.
Author: Farrah Motley | Legal Principal
PROSPER LAW – Australia’s Online Law Firm
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