Australia: Restraint of trade clauses in business sale agreements

IN BRIEF - FREEDOM FINANCE V GOLDSTEIN DECISION OFFERS VALUABLE LESSONS

The recent decision of the Supreme Court of Victoria in Freedom Finance Accounting Pty Ltd v Goldstein [2017] VSC 179 demonstrates the importance of drafting clear and concise restraint of trade clauses in commercial agreements.

In Australia, restraint of trade is a common law doctrine (with the exception of New South Wales where restraint of trade is governed by the Restraints of Trade Act 1976 (NSW)), which prevents a party from restricting another party's ability to engage in trade or employment unless it is able to demonstrate the restraint is reasonable in the interest of the parties and the public.

BUSINESS SALE AGREEMENT INCLUDES CLAUSE RESTRAINING MR GOLDSTEIN FROM SERVICING GOLDPATS' CLIENTS FOR UP TO THREE YEARS

On 10 February 2015, Freedom Finance Accounting Pty Ltd entered into an agreement to acquire accounting firm Farrell Goldstein (trading as Goldpats) for $716,595 (business sale agreement). Completion occurred on 1 May 2015, where Mr Goldstein received $385,000 for his 50% interest in Goldpats and an additional 17.5% interest in Freedom.

Mr Goldstein was restrained by the business sale agreement for up to a period of three years post-completion of the business sale from engaging in a wide variety of activities, including providing accounting or non-accounting services to clients of Goldpats within a 100 km radius of Goldpats.

After completion of the business sale, Mr Goldstein continued to work as an employee of Goldpats until 28 February 2017. Mr Goldstein sought to continue to provide accounting services to the clients whom he previously serviced while an employee of Goldpats. Freedom sought an injunction enforcing the restraint of trade in the business sale agreement preventing Mr Goldstein from continuing to provide services to these clients.

RESTRAINT OF TRADE CLAUSES AND ENFORCEABILITY COMMON LAW PRINCIPLES

In Australia, the governing common law principles for enforceability of restraint of trade clauses are:

  • a contractual provision restraining trade is prima facie void
  • this presumption can be rebutted and the restraint allowed if on the facts of the case it can be established the restraint is reasonable to provide adequate protection by reference to the interests of the parties and the public
  • the court will take a less strict view of a restraint protecting the goodwill of a business purchased by way of a business sale (goodwill covenant) than a restraint in an employment contract (employee covenant) as the employee has lesser bargaining power
  • a goodwill covenant will be considered reasonable if the restraint is confined to an area where the competition of the seller would injure the purchaser, and
  • if a part of restraint is found to be unreasonable, it may be removed from the clause if the removal does not affect the meaning of the remaining parts

GOODWILL COVENANT BASIS OF DISPUTE NOT EMPLOYMENT COVENANT, COURT DECIDES

The issue in this case was that the restraint was included in the business sale agreement but Mr Goldstein continued to work as an employee for a period of time after the sale. The Court decided that it was a dispute regarding a goodwill covenant as opposed to an employment covenant because:

  • the restraint was contained in a business sale agreement which commenced upon the sale of the business not on the completion of Mr Goldstein's employment, and
  • the clients constituted an asset which was sold for value to Freedom

As a result, Freedom's entitlement to protect its goodwill raised two main questions:

  1. was the goodwill (if any) acquired in Goldpats of a kind that could be protected by the goodwill covenant?
  2. did the restraint clause afford no more than adequate protection of goodwill?

COURT FINDS THAT FREEDOM FAILS TO ESTABLISH THAT RESTRAINT CLAUSE SHOULD BE ENFORCEABLE AND DISMISSES INJUNCTION

The Court decided that Freedom's prospects of establishing at trial that the restraint in the business sale agreement should be enforceable were poor and that the application for injunction should be dismissed on the following bases:

  • the restraint went beyond what was necessary to protect the goodwill in Goldpats, in that it prevented Mr Goldstein from engaging in "non-accounting services" after completion of the sale
  • while at Goldpats, he had only provided accounting services up until completion
  • the definition of "client" in relation to the restraint clause was rendered ineffective as Freedom failed to include the client list as an annexure to the business sale agreement, and
  • as the majority of the offending parts of the restraint could not be severed from the clause without altering the nature of the agreement the entire clause was unenforceable

McDonald J refused to grant Freedom's application for an injunction restraining Mr Goldstein from servicing the clients. He considered that Goldstein had provided sufficient notice to Freedom of his intention to terminate his employment and had engaged in discussions about reducing his equitable interest in Freedom in exchange for taking his clients. Further, Freedom was unable to prove that it suffered any actual loss of clients. Finally, if any loss had been suffered, the business sale agreement contained a clause that contemplated a method of assessing the loss.

EIGHT KEY FACTORS TO CONSIDER WHEN DRAFTING RESTRAINT OF TRADE CLAUSES TO ENSURE ENFORCEABILITY

Restraint of trade clauses in business sales are an important tool for maintaining the value of the business by preventing the seller, which will usually have the reputation and connection within the community, from going into competition with the business. As a result, this case is a timely reminder of the importance of drafting a restraint of trade clause in such a way that it is enforceable.

Key factors to consider when restraining a seller in a business sale include:

  1. It is easier to establish that a goodwill covenant is reasonable than an employment covenant.
  2. If the intention is to hire the seller to provide services after completion of the sale, consider including a specific restraint of trade clause in their employment agreement that is specific to their new role.
  3. The restraint clause and definitions must be carefully and clearly drafted so that courts can interpret the intended meaning of the restraint.
  4. Ensure that the restraint clause is specific as to the location in which it applies, what type of services it applies to and what the seller is restrained from doing.
  5. Consider specifically listing those clients with which the seller has a relationship with and to whom the restraint will apply (and remember to include the client list in the actual business sale agreement!).
  6. Courts will permit the unenforceable parts of a restraint clause to be severed.
  7. Be careful when drafting restraint clauses to ensure that they are sufficiently comprehensive to contemplate all future scenarios while being drafted in such a way that any unreasonable portions can be properly severed.
  8. Be careful when drafting a restraint clause to ensure that it covers all future scenarios so that any potentially unenforceable elements (not just distance and duration) can be severed.
Andrew Komesaroff
Business sales and purchases
Colin Biggers & Paisley

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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