Not every termination of employment ends on good terms, with a farewell lunch and thank-you card full of best wishes for the future. Employees may leave an organisation disgruntled, or alternatively, full of ambition to ‘make it’ with another employer, by profiting from your trade secrets, soliciting your clients, or capitalising on inventions created during the course of their employment with you. Intellectual property and confidential information are amongst a company’s most valuable assets. This is why when it comes to employees, and it is important to be on guard against potential breaches of post-employment restraints which can be incredibly damaging to your business.
The law presumes that competition is good, and accordingly, that restraints on competition are bad. This means that all restraints on competition are unlawful except to the extent that they are reasonable. A restraint on competition must not be contrary to the public interest.
Notwithstanding these principles, any and all employees may be bound by post-employment restraints in their employment contracts. Restraints commonly found in employment contracts usually set out that:
- 1. Confidential information should not be stolen
- 2. Employees and contractors should not be poached
- 3. Clients, customers and suppliers should not be poached
- 4. Employees should not work for a competitor or otherwise compete with their employer
However, such restraints must be carefully drafted to ensure that they are ‘reasonable’. Reasonableness is assessed against three criteria:
- (a) That there is a genuine business interest that must be protected by a restraint of trade.
- (b) That the timeframe during which the restraint applies is reasonable.
- (c) That the geographical reach of the restraint is reasonable.
An employer should not generally have trouble enforcing restraints 1 – 3 above in the Courts, however enforcing restraint 4 can prove to be a bit more difficult, as Courts are reluctant to hold that restraining employees from participating in the free labour market and gaining alternative employment is in the public interest. Nevertheless, any restraints can be enforced to the extent that it is reasonable, given the employee’s role within the business, his or her seniority, and possession of confidential information. Generally speaking, the more senior the employee’s role, and the more possession of confidential information they have, the longer that a restraint may be enforced.
Finally, it is important to note that Courts will only protect confidential information provided it is treated as, and is in fact, secret and confidential. Courts will not protect material which is not proprietary or capable of being described as confidential. However, truly confidential information can be protected indefinitely, or until by other lawful means it is released into the public domain.
Four-year restraint upheld
On 14 August 2017, the Victorian Supreme Court handed down a decision to restrain an IT specialist from working for a competitor and encouraging other employees to join him. The employee had a significant financial stake in the company and was described in the proceedings as a “key employee”.
The Southern Cross Computers Pty Ltd employee entered into a restraint of trade clause for up to four years until June 28, 2020, when he sold his 40% share in the business for $3.5 million to Ingenio Group Pty Ltd in June 2016.
However, the employee began to work one day per week with a direct competitor, Blue Connections Pty Ltd, receiving $5000 per month in return.
Justice Michael McDonald found that Southern Cross Computers was entitled to an order restraining the employee from working for Blue Connections until 2020 and attempting to solicit his employees to join him.
The restraint was held to be reasonable because (i) the employee was key to the business, (ii) the term containing the restraint was freely entered into by the employee’s company, (iii) the employer paid a substantial amount of money in return for the terms of the share sale agreement, and (iv) the share sale agreement allowed the employee to continue his employment, and would not operate until the expiration of the employee’s fixed-term contract with the employer.
This case demonstrates that employees with shares in a business may be restrained via a share sale agreement, not just their employment contract. The decision is also significant because employment contracts often specify a restraint of six months, or twelve months at the most. The fact that the Court, in this instance, enforced a restraint of four years demonstrates that it may be worth lengthening restraint periods for senior employees, or employees with access to significant intellectual property or confidential information.
Citation:Southern Cross Computer Systems Pty Ltd v Palmer (No 2) VSC 460 (14 August 2017)
Repudiated contract renders restraint unenforceable
In contrast, the Victorian Court of appeal rejected financial services firm Crowe Horwarth Pty Ltd’s appeal to enforce post-employment restraints against a senior accountant who sought to provide accounting services to its clients and start his own boutique firm in Launceston, Tasmania. The key reason that Crowe Horwarth was not able to enforce the restraint was because it breached the employment contract by changing the bonus payment scheme and the employee’s role within the firm.
Crowe Horwarth paid bonuses to employees each year under an incentive scheme. Eligibility for such bonuses was based on prescribed mandatory criteria, including employee’s performance and broader economic conditions, but the final decision regarding payment of bonuses remained the prerogative of management. In June 2016, the business informed employees that it was planning to defer payment of 20% of the annual bonuses and distribute that component over three years.
The senior accountant argued that this was a repudiation of his employment contract and left the firm. He argued that there was nothing in his employment contract that authorised his employer to withhold a proportion of the bonus. He accordingly left the firm.
The Court applied the seminal authority on the subject, a House of Lords decision from 1909 – General Billposting Company Ltd v Atkinson. That decision established the principle that an employer, having breached an employment contract and brought it to an end, should not be permitted to rely upon a restraint clause contained within it.
The employee is now unfettered by his restraint and may seek to poach his former employer’s clients and establish a rival business.
Citation: Crowe Horwarth (Aust) Pty Ltd v Loone VSCA 181 (7 July 2017)
- â— Ensure that your employment contracts contain post-employment restraint clauses that cover the four categories of restraint outlined above. Further, ensure that such clauses are reasonable, considering the role that the contract is for.
- â— Ensure that such post-employment restraint clauses identify the legitimate business interest that must be protected. This interest should only be protected for the timeframe that it would take your business to redress any potential disadvantage arising from an employee breaching the restraint.
- â— Ensure that confidential information is treated as such within the business. Documents should be marked as ‘Commercial in Confidence’, ‘Highly Sensitive’, or ‘Confidential’ where necessary.
- â— Include a restraint clause in sale agreements for employee shares.
- â— Uphold your side of the bargain – ensure that you have not repudiated the employment contract at any time, so that you are able to enforce the restraint if necessary.
- â— Remind employees who you perceive to be at risk of breaching their post-employment restraints of their obligations. This could be done when you accept their resignation, or in the case of a termination, in the termination letter.
- â— Ensure data security processes are in place. Access to the company’s confidential information should be cut off immediately upon termination. If at all possible, monitor employee’s access to company data throughout the notice period and if necessary, be on guard for hacking activity for a reasonable period (we recommend at least ninety days) after the termination.
Published: 24 August 2017