Seeking to restrain a former employee from competing with their former employer is a controversial area of law. A properly constructed restraint may provide a level of protection against an employee who seeks to work in direct competition with their former employer or who attempts to seize its customers, suppliers or staff. A restraint must operate within the competing interests of the employer's right to protect their business and the employee's freedom to compete, work and earn a livelihood. The success of restraints depends largely upon whether the restraints as applied to an employee, are no more than what is reasonable to protect the employer's legitimate business interests.
General Principles & Enforceability
How does restraint operate?
A restraint of trade will usually operate to restrict or place limitations on the conduct of an employee after the employee leaves employment. A restraint clause may restrict the employee from approaching clients, soliciting staff, working with a competitor business (usually by reference to temporal and geographical criteria).
The Common Law
Courts have generally taken a stricter and less favourable view of employee restraints of trade as compared with similar restraints in commercial arrangements. However the law recognises that employers have legitimate interests capable of protection by a restraint.
Generally speaking, in the absence of a restraint provision in the employment contract, an employee, may after termination of employment, canvass customers of their former employer for business. Therefore it is critical to consider whether a restraint should be included to protect the employer's legitimate business interests particularly in relation to 'customer connection', at the commencement of the employment relationship.
What is a legitimate interest?
The traditional common law position presumes that a restraint will be void and unenforceable unless it can be rebutted by the party relying upon it establishing that the restraint is no wider than reasonably necessary to protect a legitimate interest. This prescription requires an employer to show that the restraint is reasonable in that:
- The restraint is intended to protect some 'legitimate interest ' of the employer; and
- The restriction imposed on the employer is commensurate with the interest to be protected, and is no greater than is strictly necessary to protect the interest.
The courts will give considerable weight to what the parties have negotiated and set down in their contracts, but simply relying on contractual consensus and agreement between the employee and employer, cannot be regarded as conclusive to enforce a restraint. Even where there is acknowledgement by the employee that the restraint is reasonable, it may not be enough to ensure that the restraint will be found to be valid. The specific content and drafting of the restraint clause should be tailored to the individual circumstances of each employee. The validity of a restraint of trade clause will be tested at the time the contract was entered into and with reference to what the restraint entitles or requires the parties to do. Generally speaking, courts have refused to read down an excessive or unreasonable restraint in order to make it reasonable. That is to say, only if the unreasonable part could be severed, (without destroying the meaning of the provision) would the court attempt to make a particular restraint reasonable (and therefore enforceable). In response to this approach by the judiciary, New South Wales enacted the Restraint of Trade Act 1976.
Restraint of Trade Act 1976 (NSW)
The Restraint of Trade Act may operate in some instances to permit the reading down and/or severance of a restraint of trade provision that would otherwise be unenforceable, but only to the extent that it is not against public policy.
Example of reading down a restraint under the Act In a recent NSW Court of Appeal decision, the restraint clause in question purported to prevent a former senior employee of Woolworths from accepting employment with a 'competitive business' for a period of time following termination of the employment relationship. The employee was also paid for the relevant restraint. Applying the Restraint of Trade Act, the court read down the restraint and ordered modification of its terms such that the employee was to be restrained until a specific date before which he or she could not be 'engaged involved or otherwise interested in or concerned with Franklins Pty Limited (his new employer) or any other supermarket business with which Woolworths Competes in Australia.' (Woolworths Limited v Mark Konrad Olson and Anor  NSWSC 849).
There are a number of approaches to the drafting of restraint of trade clauses. A popular method is by use of 'cascading' clauses. 'Cascading' involves a restraint covenant which offers clear choices to the court through the drafting of alternative combinations of temporal and geographical restraints. The court is able to select from the 'cascading' clauses (where appropriate), the combination which provides what it regards as a reasonable restraint in all the circumstances. Cascading provisions therefore offer a flexible approach and may result in a restraint provision being restricted by the court in its operation, without it being held to be unenforceable.
Some examples of how courts have interpreted restraint of trade clauses
'Solicit': The individual words of a restraint and their application to the relevant circumstances will be critical to whether a restraint is upheld. In the case of Barrett and Ecco Personnel Pty Limited the High Court (in a special leave application) considered the meaning of the word 'solicit ' which appeared in a clause which restricted a former employee from taking any action to 'canvass, solicit, interfere or entice away' any client of the employer. In this instance the word 'solicit ' was interpreted broadly, so that acting upon a contact initiated by a client of the former employer was considered to fall within the definition of 'solicit '. (Barrett & Ors v Ecco Personnel Pty Limited S198/1998 10 September 1999).
'With whom the employee had contact': In a decision of the Victorian Supreme Court, it considered a restraint clause which prevented the former employee from being engaged in, involved or associated with a business customer 'with whom the employee had 'contact ' in the course of their employment. The court considered that the 'contact ' by the former employee with a client could have been fleeting or of no significance or have occurred many years prior to the termination. The restraint was therefore held to be unreasonable on the basis that the nexus between the employee and the customer was so widely expressed as to render it unreasonable - Roberts Research Group Pty Limited v Pyra  VSC 16 (11 February 2008). This is an unusual decision and it is uncertain as to whether it will be followed.
How can a restraint of trade provision be enforced?
'Interlocutory injunction': An employer may make application to a court for an injunction to restrain an employee from an apprehended or existing breach of a restraint provision. While the injunction is usually sought and decided on an interim basis, its grant often determines the outcome of the matter. Whether an injunction is granted is a matter entirely at the discretion of the court. In considering whether to grant an injunction, the court will consider the strength of the employer's case and whether the 'balance of convenience' favours the granting of an injunction.
Damages will invariably be claimed in proceedings brought to enforce an alleged breach of restraint.
Express contractual obligation
An employer should protect its confidential information (which comes into the possession or control of employees during the course of employment) by imposing contractual obligations on its employees to this effect. This is usually achieved through express terms in the employee's contract of employment, or by a Deed dedicated to this topic (which also usually addresses IP issues) and also through company policies dealing with the employer's confidential information. It should be appreciated that there are risks in simply relying on the implied common law obligation to protect this information.
As a general rule, the common law imposes on former employees (regardless of any express contractual provision) a duty after (ceasing employment) not to use confidential information obtained during the course of their employment for the purpose of competing with their former employer or for use in a manner detrimental to the former employer's interests.
Following the end of the employment relationship the former employee will have equitable obligations in relation to any confidential information that they have in their possession, to deliver up and return the confidential information to their former employer.
For example, where an employee takes copies of a list of customers which were initially prepared for legitimate purposes in the course of their employment, the departing employee must no longer use or disclose the confidential information (eg to compete) and must return these lists to their former employer.Types of information in employment
Generally speaking, an employee will acquire information via their employment which forms part of the employee's 'stock of general knowledge, skill and experience'. This information is not regarded as confidential at law, and the employee is free to use it after their employment ends.
An important distinction: The courts have emphasised that there is an important distinction to be drawn between 2 types of confidential information belonging to an employer and to which an employee may be exposed:
1. The first category is information which is protected as confidential information during (and possibly after) the employment relationship. This includes, for example, customer lists, business plans and inventory orders. Such information is specific to the employer's business and cannot be disclosed by the employee during the employment relationship except as authorised by the employer. This condition is tied to the employee's implied obligation of 'good faith' to the employer (which exists during the currency of the employment relationship). Once the employee leaves their employment however, this category of information may be used by the employee if it is not protected under equitable principles by the common law as 'confidential information', or protected by an express term such as a confidentiality covenant in their employment contract.
2. The second category is a higher level of confidential information called 'trade secrets' (discussed below) which will impose an obligation of confidentiality both during and after the employment relationship ends. That is to say the employee has a continuing duty after employment ceases not to disclose this information even in the absence of an express term in the contract.
Trade Secret: A class of confidential information A trade secret is a special class of confidential information. It is usually categorised an valuable commercial information which is highly secretive and which an employer has gone to considerable effort to keep confidential. At the very least, the information must have the necessary quality of confidence about it and it must have been communicated in circumstances importing an obligation of confidence or secrecy.
It is important to note that the duty of confidentiality owed by the employee to protect secret information of the employer will only be upheld where the information has been treated by the employer as having that quality. Where an employer has made no particular effort to safeguard or prevent the information from freely circulating within or outside its business, a claim against an employee who takes it away and subsequently uses it will fail, even where the use of that information could cause the employer significant damage.
In today's business environment it is highly desirable for most if not all employers to ensure they have effective and binding obligations on their employees which protect their confidential and business information. Depending upon the nature of their business, its culture and the type of employee concerned, employers should also protect their goodwill and business contacts with effective restraint of trade provisions. The complexity of drafting contractual provisions which adequately address these issues, informs the need to take dedicated legal advice.
Swaab was recently named winner 'Best Law Firm in Australia (Revenue < $20m)' and 'Attribute Award for Exceptional Service (Australia Wide)' and at the 2008 BRW- Client Choice Awards.
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.