Restraint of trade clauses: lessons for employers

by Megan Kavanagh, Brendan Pearce, Emily McRae
27 April 2017

In brief - Do your restraint clauses reflect the protection intended?

Well-drafted restraint of trade clauses in employment contracts are the only way employers can prevent former staff poaching their clients and staff. However, in drafting such clauses employers should consider how the restraint legislation varies from state to state, understand what the courts will consider "reasonable", ensure that employees understand the effect of such clauses, and how cascading clauses may (in some instances) provide an advantage should a court find other clauses to be unreasonable. 

Court upholds majority of restraint clauses in a partnership agreement

The recent successful enforcement of some post-employment restraints against a number of exiting partners in a legal partnership has been widely reported. Although not all clauses in the Partnership Agreement were enforced, the New South Wales Supreme Court granted a wide-reaching interlocutory injunction preventing the former partners of the partnership from soliciting any clients or employees of their former partners for a six-month period, or until permanent orders are made. 

The former partners left to join a new law firm on 1 March 2017 following each of them working out a six-month notice period. The remaining partners made an application seeking interlocutory injunctive relief to restrain the former partners from joining or working for another firm, and otherwise breaching the terms of restrictive covenants in the Partnership Agreement.

Although the Court allowed the former partners to work for the new firm during the six-month restraint period, the majority of the restraint clauses in the Partnership Agreement were upheld, meaning that the former partners' working and recruitment capacity will be severely limited. 

How employers can use restraint clauses to protect their business interests

Employers who want to protect their legitimate business interests in preventing former staff poaching their clients and staff have important lessons to learn. 

These lessons include:

1. Be aware of the legislation framing restraint of trade in your jurisdiction

The common law doctrine of restraints of trade captured in the Restraints of Trade Act 1976 (NSW) (relevant in this case) and the Competition and Consumer Act 2010 in Australia renders any provision which imposes restrictions on an individual's freedom to trade or take employment illegal and unenforceable, unless it can be demonstrated that the restriction is reasonable having regard to both the parties' interests and to the public interest. 

Having regard to the law (and it varies from state to state) it is essential your post-employment restraints are drafted to meet the statutory and common law tests applicable in the relevant state/s. Failure to have regard to the law may mean that the restraint has little chance of being enforced. 

2. Understand what is meant by the term "reasonable"

In determining whether a clause is "reasonable" the court will consider each clause of the restraint on a case-by-case basis. The courts will have particular regard to:
  • what was reasonable when the restraint was entered into by the employee
  • the period of the restraint: the courts are concerned to ensure that the period of the restraint is no longer than is reasonably necessary to protect the value of confidential information or client and staff contacts
  • the geographical limit of trade clause: the courts are unlikely to enforce a restraint that is geographically wider than the legitimate business interest that the clause is trying to protect
  • the extent of the restraint of trade clause: the courts will consider the activities that an employer/partner is trying to prevent an employee from engaging in. Restrictions are only likely to be enforced to the extent that they go to protecting legitimate business interests, and do not extend beyond what is necessary to protect those interests 
It will be difficult for a clause to protect a legitimate business interest if it cannot be defined.

This means that rather than allowing for generic or standard restraint clauses in contracts, deeds or agreements, employers should exercise real care when instructing their lawyers in the drafting of these clauses if they are to have any prospect of being enforced at a later time.

3. Take into account the knowledge and experience of your employees

One of the key considerations taken by the Court in this case was the knowledge and experience that framed the partners' understanding of how the restraints worked when they each entered into the agreement. 

Since each of the individuals signing the partnership agreement were "commercially and legally sophisticated", the Court was reluctant to substitute its own commercial judgment for that of the partners. 

The Court noted that partners were aware of the consequences of the terms of restraint that they agreed to, so there was less reason for the Court to "relieve them of the consequences of what must have been a careful decision".

With this observation in mind, it may be useful for employers, when proposing restraint provisions, to provide specific instruction or information to employees about the effect of such clauses. Employers should encourage prospective employees to obtain legal guidance before entering into such arrangements to improve the enforceability of such clauses.

4. Consider using ladder or cascading clauses

The Partnership Agreement in this case provided guidance on how the protections should be interpreted. The clause stated that it is open to the court to order that only some of the preceding restraints be enforced, if it concluded that others were unreasonable and hence void restraints of trade. This allowed the Court to vary the restraints by removing unreasonable clauses. 

By taking advantage of ladder or cascading interpretation clauses, employers can allow for less strict clauses to survive, should other clauses be found to be unreasonable by the court. 

However, the use of these clauses should be exercised with absolute caution. Previous cases suggest that should the court decide that employers have not made a genuine attempt to define the protection, or that the clauses are so uncertain they could not have been agreed upon, the restraint may fail. In some states cascade clauses might be more problematic than in other states where specific restraint legislation exists. 

Ultimately employers should ensure that any restraint clauses specifically define what amounts to a reasonable restraint. Employers should avoid "broad" or "catch all" clauses which may require the court to "create" or "restrict" the restraint. 

Seek legal advice to manage risk of poorly drafted restraints not providing intended protection

When you entrust any employees or partners with the keys to your business success—whether that be access to confidential information, the opportunity to develop relationships with your key clients, or the chance to work with the people you have recruited, developed and invested in—you are taking a risk: a risk that they will want to emulate your success for themselves or for someone else. 

The only chance you have to protect against this risk is via a restraint. 

The case demonstrates that if you don't have regard to what the law requires, including defining the interest you are trying to protect, if you don't ensure that those signing up to a restraint understand what they are agreeing to and if the form of the clause is not right, then your restraint might not provide the intended protection.

This article has been published by Colin Biggers & Paisley for information and education purposes only and is a general summary of the topic(s) presented. This article is not specific legal advice. Please seek your own legal advice for any questions you may have. All information contained in this article is subject to change. Colin Biggers & Paisley cannot be held responsible for any liability whatsoever, or for any loss howsoever arising from any reliance upon the contents of this article.