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What is a Restraint of Trade Clause?

Reading time: 12 mins

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.

Restraint of trade clauses are also known as non compete clauses.

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.

We cover the following topics:

  1. What is a restraint clause?
  2. A restraint of trade clause must protect legitimate business interests
  3. A non compete clause is limited to a time period
  4. A restraint of trade clause is limited to a location
  5. A restraint of trade clause must not go against public policy
  6. Why NSW is different when it comes to non-compete clauses
  7. Is your restraint of trade clause reasonable?

Farrah Motley wrote this article. She is the Director of Prosper Law and an employment lawyer. Farrah has advised hundreds of Australian employers and workers regarding restraint of trade clauses.

What is a Non Compete 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:

  • A Non compete clause that prevents a person from creating or joining a business that competes their former employer (or, in the case of a contractor, their client) for a certain period of time.
  • Non solicitation clauses prevent a person from soliciting their former employer’s clients for a certain period of time.
  • Non recruitment clauses 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 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 non compete 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.

non compete clause

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 protection.

Generally, courts are more willing to enforce a non-compete clause if it relates to the reputation and goodwill regarding the sale of a business. On the other hand, Courts are more reluctant to uphold a non-compete clause that tries 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. This means the employee has little power to negotiate the terms of the non-compete clause with their employer.

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 non-compete clause should identify the interest that the business is trying to protect.

A Non Compete 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;

(b) Australia;

(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.

Why NSW is different when it comes to non-compete clauses

The Restraints of Trade Act 1976 (NSW) only applies to contracts governed by NSW law.

The significance of a contract being governed by NSW is that the Restraints of Trade Act allows a Court to ‘read down’ a non-compete clause. For example, even if the contract does not state a restraint period of two months, a Court could decide that two months is a reasonable period to refrain someone from competing.

On the other hand, no such law exists in Queensland, Victoria or other States and Territories. If a contract is governed by a State or Territory law other than NSW, a Court must either uphold the clause or strike it out. They cannot determine a different restraint period or geographical reach.

Restraint of Trade Clause

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:

  1. they impact a person’s ability to earn money;
  2. they may go beyond what is reasonably necessary to protect a company’s legitimate business interests;
  3. 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.

Restraint of Trade Clauses in Case Law

Restraint of Trade Case Law TitleSummary of Case and Where to Read
Hunter v. Koulouris [2011] NSWSC 887
You can read the full case here.

The New South Wales Supreme Court considered whether a restraint of trade clause in a business dissolution deed was reasonable.

Hunter and Koulouris exclusively imported and distributed solar film products.

The partnership ended in 2008. The parties signed a deed whereby Hunter purchased Koulouris’s share of the business.

The deed contained a non-compete clause that prevented Koulouris from competing with Hunter’s business for a period of five years.  The restraint clause also stated that “the prohibitions and restrictions contained in this clause are reasonable and necessary to protect the business of” Hunter.

Hunter then found out that Koulouris had started a business in the solar film industry through his wife.

Hunter pursued Koulouris in Court.

The Court ultimately found there was a breach of the restraint of trade clause.
 
The test considered was, “the time required for severing the relationship between [Koulouris] and those clients who would patronise the business after its sale
Rich v BDO Kendalls [2007] QCA 147
You can read the full case here.

Mr Rich was a partner of the accounting firm BDO Kendalls. He retired as a partner on 30 June 2005 but then became an employee of the firm for a year until 30 June 2006.

He then took a job as an in-house accountant for a client of BDO.

BDO sought an injunction against Mr Rich and claimed that he was in breach of the restraint clause in his partnership agreement with BDO. The restraint clause prevented Mr Rich from working for clients of BDO, was unlimited as to area and had a number of alternatives as to time ranging from one year to three years from Mr Rich’s retirement as a partner. 

The court decided that a restraint against all clients of the firm was justified and not just the clients Mr Rich acted for as partners share the assets of the firm and its goodwill.

The restraint was limited to clients of BDO and therefore Mr Rich could still work and offer his services to many other people. 
Freehills & White and Case LLP
You can read more about this case here.

Eight partners of Freehills gave notice of their resignation at the same time, on 1 September 2016. They had been poached by White & Case LLP (“White & Case”).

Freehills tried to enforce the restraint of trade in its partnership agreement. That restraint of trade clause attempt to prevent the partners from soliciting clients and employees of Freehills, and from commencing work with White & Case, within a six-month period following the expiry of each defecting partner’s notice period.

Those partners argued that the non compete clause was unenforceable. They said that Freehills was avoiding competition in the legal services market, not protecting its legitimate interests.

Freehills then applied to the New South Wales Supreme Court for an injunction.

The NSWSC granted a partial injunction in favour of Freehills. A confidential settlement was then reached. 

It is understood that the terms of settlement enabled the partners to commence work with White & Case, provided that they were restricted from soliciting Freehills’ clients and employees until the restraint period ended.
Allied Mills Pty Ltd v Miners [2013] NSWSC 1117
You can read the full case here.

In this case, the NSW Supreme Court refused to grant an injunction to Allied Mills to prevent its former National Sales Manager from taking up a role as a grain procurement manager with a competitor in New Zealand.

The Court found that the “likelihood of genuine harm” to Allied Mills was “remote and tangential” and there was no reason that post-employment restraints in NSW would be breached by Mr Miners taking up a role in New Zealand.

The arrangements for Mr Miners to work in New Zealand had arisen from discussions that Mr Miners had with Allied Mills. He sought to be released from the 6 months non-compete restraint contained in his contract. This was to enable him to take up a position in Sydney.

When Allied Mills failed to consent to a release, Mr Miners was offered the role in New Zealand so as to avoid any potential breach of the restraint.

The Court criticised Allied Mills for bringing a case “so broad and general, that no useful purpose would be served, on the facts of this case, in making those declarations or granting those injunctions”. Mr Miners had been “so concerned to ensure that he does the right thing by his former employer” to go as far as to include a clause in his new employment contract with his new employer to the effect that he would honour his post-employment restraints.

How can Prosper Law help?

We know how non compete 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 our employment lawyers today for a free, no-obligation, fixed-fee quote.

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