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Restraint of trade clauses also known as non-compete clauses or restrictive covenants are contractual terms where a party, usually the employee/independent contractor, agrees not to engage in activities that could harm another party’s, usually the employer/company, business interests. These activities often include soliciting customers/clients, directly competing, or sharing confidential information. Such clauses appear in various agreements, including:

  • Employment contracts
  • Independent contractor contracts
  • Consultancy agreements
  • Business sale or share sale agreements
  • Franchise agreements
  • Shareholders agreements

In industries with high employee turnover and low entry barriers, restraint clauses can be vital for protecting business interests.

Some general restraint clause can look like the below samples

“Employees shall not at any time during the term of their agreement, or for the period of 12 months after they leave the company:..”

“In order to protect the employer’s propriety interests, for six months after the termination of this contract, the employee shall not engage to work for or on behalf of an organisation in direct competition with this company, nor establish your own business in competition with this company…”

Ensuring Enforceability of Restraint Clauses

General Court Perspective

While restraint clauses can safeguard business interests, it is important to note that their enforceability is not guaranteed. Generally, courts view these clauses skeptically as they can conflict with the public policy principle that individuals should have the freedom to work and earn a living. Nevertheless, courts do acknowledge that restraints can be justified under certain conditions.

Key Considerations for Enforceability

To determine if a restraint clause is enforceable, courts typically consider two primary questions:

  1. Is there a legitimate interest at stake?
  2. Is the restraint reasonably necessary to protect that legitimate interest?

Identifying Legitimate Interests

A legitimate interest must be specific and identifiable, such as protecting trade secrets, confidential information, or business goodwill. A general interest, like preventing a former employee from using their skills in a competing business, is not sufficient.

Evaluating Reasonableness of the Restraint

For a restraint to be enforceable, it must be no more extensive than necessary to protect a legitimate interest. Courts evaluate various factors, such as:

  • The specific interest being protected
  • The characteristics of the parties involved
  • The prohibited activities
  • The geographical scope of the restraint
  • The duration of the restraint
  • Consideration paid for the restraint
  • Industry standards

An illustrative case is McMurchy v Employsure Pty Ltd; Kumaran v Employsure Pty Ltd [2022] NSWCA 201. In this case, the court upheld a 9-month restraint for a former sales manager with access to confidential information but not for another who lacked such access.

For another example, in Just Group Ltd v Peck [2016] VSCA 334, the employer sought to prevent the company’s Chief Financial Officer from working with a competitor. The court ruled that the restraints were unreasonable because:

  • The restraint attempted to prevent the employee from working at businesses that were not competitors of Just Group Ltd.
  • The duration was excessively long, as the clause applied to Australia and New Zealand for two years after her employment ended.

Consequences of Unreasonable Restraints

Common Law Approach

If a court finds a restraint clause unreasonable, it may apply the “blue pencil test,” striking out parts of the clause to render it reasonable. However, this can sometimes result in the entire clause being voided, leaving the legitimate interest unprotected.

New South Wales Specific Approach

In New South Wales, the Restraints of Trade Act 1976 (NSW) allows courts to modify unreasonable restraint clauses. This means courts can adjust the clause to provide some level of protection for the legitimate interest, rather than simply striking it out.

Approaches in Other Australian States and Territories

Unlike New South Wales, other states and territories in Australia do not have specific legislation. Consequently, courts in these regions rely solely on the common law approach. This means they apply the “blue pencil test” without the ability to modify the terms of the restraint clause. If a restraint is found to be unreasonable, it is either partially struck out to make it reasonable or completely invalidated if it cannot be reasonably adjusted through omission.

Practical Steps

Drafting Effective Restraint Clauses

To ensure a restraint clause is enforceable, it should be carefully drafted to fit the specific facts and circumstances. Considering the evolving standards of what is “reasonably necessary,” it is beneficial to include flexibility in the clause. Working closely with legal professionals can ensure that restraint clauses are appropriately crafted and legally sound.

Addressing Breaches of Restraint Clauses

If there is a concern that a restraint clause has been breached, immediate action is crucial to prevent further violations and avoid appearing to condone the conduct. Typical steps include:

  • Issuing formal cease and desist letters
  • Informing involved parties about the alleged breach

In some cases, formal legal action, such as seeking an injunction, may be necessary to enforce the restraint. Proving a breach can be challenging, so consulting legal counsel promptly is advisable to determine the best course of action.

Need help with HR?

Employers, who need help regarding the above or any other employment law questions, can contact BetterHR’s experienced HR consultants, and qualified lawyers on 1300 659 563 or visit: Subscribe to BetterHR.