When running a business, you will inherently find yourself in competition with other businesses and companies in your industry or market area.
However, it is not uncommon to find your best employee has decided to move on to work for a competitor; nor is it rare for an employee to resign with ambitions to start their own business in direct competition to you.
So, what can you do when a valuable employee suddenly becomes the competition?
Restraint of trade clauses
To protect themselves in the event of an employee’s exit, many Australian businesses regularly include restraint of trade clauses in their employment agreements.
Employers may use these clauses to try to prevent former employees, as well as contractors or suppliers, from:
- Competing against the former employer;
- Soliciting clients; or
- Poaching other employees.
Restraints are often also used to protect the employer’s or customer’s confidential information, in conjunction with standalone confidentiality clauses.
Validity of restraint clauses
Restraint clauses are legally presumed to be void, as it is considered contrary to public policy to unreasonably prevent a person from lawfully obtaining gainful employment.
However, there are some circumstances in which the court may override this presumption and find a restraint clause to be valid and enforceable. The key principle is reasonableness.
A restraint clause will be considered ‘reasonable’ when it restricts no more than is reasonably necessary to protect the employer’s legitimate commercial interests.
An employer does not have a legitimate interest in merely protecting themselves against competition as such. Instead, the employer must demonstrate special circumstances that justify the need for the restraint.
These circumstances may include:
- The scope of the employment;
- The nature of the employer’s business;
- An employee’s connection to clients;
- Access to confidential informational or trade secrets; and
- Whether the employee received any compensation or remuneration for the restraint.
Employers will also often specify both a restraint period and a geographical area for which the clause applies. However, the court will consider whether the duration and reach of the restraint goes beyond what is adequate in protecting the employer’s interest.
In Pearson v HRX Holdings, the Federal Court found that a lengthy restraint against HRX co-founder, Mr Pearson, was reasonable.
HRX, an HR company, sought to enforce a restraint on Mr Pearson preventing him from working within the HR industry for 2 years.
The court held the restraint was reasonable because:
- Pearson was vital in building and retaining the company’s client base, and was considered the ‘human face’ of the company;
- He had access to all the company’s confidential information;
- The two-year period reflected the average client contract length and gave the company reasonable opportunity to renew these without competition from Mr. Pearson; and
- The clause was negotiated and specifically tailored to Mr. Pearson, and in exchange for the restraint, Mr. Pearson would receive his salary for the restraint period as well as an 8% shareholding.
By comparison, in Just Group v Peck, the restraint clause was determined to be unreasonable.
Just Group attempted to enforce a restraint preventing Ms Peck, former CFO, from working with their competitor, Cotton On.
The clause attempted to restrain Ms Peck for 2 years from carrying on “any activity, the same or similar to” her role with Just Group in Australia and New Zealand. The clause also referred to a list of 50 brands Ms Peck would be prevented from working with.
The court determined that this restrained went beyond what was required to protect Just Group’s legitimate business interests, considering that:
- “Any activity” undertaken by Ms Peck as CFO was likely to be similar in any CFO role or similar position;
- The clause was too broad and prevented Ms Peck from working with any other fashion brand or retailer, including non-competitors; and
- The list of 50 brands included a majority that were not in competition with Just Group.
Just Group had given enough evidence proving Cotton On was a competitor, and if the clause had been more specific towards the brand, the restraint may have been enforceable. However, the court held the annexure was to be read as a whole and could not be re-written later in attempt to restrain Ms Peck from working with a specific competitor.
These cases highlight the importance of restraint clauses being drafted to be specific to an organisation’s precise business interests.
If you are an employer or customer wanting to include restraint of trade clauses in your agreements, it is important to remember that the reasonableness of a restraint of trade clause is determined by the specific nature and circumstances of your business and the individual employee or contractor.
If you would like more information on restraint of trade and confidentiality clauses to protect your business, contact us.
Author: Blake Motbey, Paralegal.