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HG Alert: Restraints of Trade: Key lessons for employers - 28 Feb 2011

In tight economic times, employers are more willing to start proceedings to enforce restraint of trade or non-compete clauses against departing employees.

In a number of recent decisions, employers have successfully prevented former employees from competing with their business or poaching their clients for the benefit of the employee's new employers.

While these decisions demonstrate the benefit of well-drafted restraint of trade clauses, they should also prompt employers to ask potential new employees whether they have a restraint of trade clause in their old employment contract. If they do, the new employer should determine whether the clause will allow the employee to perform the work they have been, or will be, hired to perform, or how any ongoing restraint obligations might best be managed to achieve the new employer's commercial objectives.

Key lessons for employers

While it depends on the facts of each case, recent decisions make it clear that properly drafted restraint of trade clauses will be enforced by the Courts where it is reasonable and necessary to protect the employer's legitimate business interests.

It is therefore important to properly draft restraint of trade clauses, so as to maximise the likelihood that the clause will be enforced in appropriate circumstances. Employers will need to consider what the employee does, with whom they have dealings or relationships, and what the employer wants to - and legitimately can - prevent them doing after the end of their employment.

It is equally important for employers to consider whether a potential new employee is subject to post-employment restraints under an employment contract with their old employer.

Depending on the wording of any post-employment restraint clause, employees might be prevented from either starting work for you, or performing the very work you have employed them to perform, for a period of time.

Alternatively, identifying the extent to which the post-employment restraint obligations of a new employee are or are likely to be binding at an early stage of the recruitment process will help you develop strategies to manage those obligations while they endure, so as to avoid disputes with the employee's former employer.

Ross and Anor v Ice TV

Two senior executives of Ice TV were prevented from soliciting clients or competing with their former employer's business for 12 months after the termination of their employment contracts.

Ice TV distributed an electronic program guide known as the Ice Guide. It alleged that the executives breached their non-solicitation clauses when they undertook consulting work for Mobilesoft, a software engineering company, within their 12 month restraint period. Ice TV had entered into discussions with Mobilesoft, with a view to Mobilesoft becoming a customer of Ice TV.

The executives' employment contract said that they must not, during their employment or for a period of 12 months after it ends:

  • carry out or be engaged or involved in any business similar to or competitive with the business of Ice TV carried on in the 12 months before termination;
  • canvass or solicit the custom of any person who has entered into discussions or negotiations with Ice TV during the 12 months before termination of employment with a view to becoming a customer; and
  • divulge confidential information including performance reports, operation reports, profitability forecasts, business plans or normal financial information that may be of commercial value to a competitor.

The Court found that Ice TV had a legitimate interest in protecting its current customer base. In particular, it had an interest in protecting prospective customers with whom it had entered into discussions or negotiations, and maintaining the confidentiality of information that might have been utilised in the course of discussions or negotiations with such customers or potential customers.

The restraint was found to extend to potential clients with whom negotiations and discussions had occurred, but who had not yet ordered products or services. Such a restraint was held to be legitimate, as the process of building up a relationship to the point where a bundling arrangement could be entered into was prolonged and delicate.

The 12 month restraint was found by the Court to be reasonable in the circumstances. The senior executives were involved in high-level negotiations with potential customers, including Mobilesoft. Their status in the company meant they held knowledge of matters relevant to pricing and technology, and had developed relationships with potential clients.

Hanna v OAMPS Insurance Brokers Ltd

In this case, the validity of a 'cascading' restraint in the employment contract of an insurance broker was upheld.

The broker had been employed by OAMPS for approximately 20 years. He resigned and accepted an offer of employment with a rival broking firm. Three clients indicated that they intended to follow him.

His employment contract contained a cascading restraint clause, which provided for nine separate post-employment restraints. The widest restraint was for a period of 15 months in the whole of Australia, and the narrowest for 12 months in metropolitan Sydney. OAMPS sought to prevent the broker from providing services to a specified list of its clients.

Initially, the Court restrained the broker from dealing with 17 clients for a period of 12 months within Australia. The broker appealed on various grounds, including that the restraint was invalid because it was uncertain and went beyond what was reasonably necessary to protect OAMPS' interests.

Importantly, clause 4 of the restraint stated that "Each restraint contained in this deed... constitutes a separate and independent provision, severable from the other restraints."

On appeal, the Court decided that the restraint was not uncertain. It found that there were nine separate restraints, ranging from the widest to the narrowest, and that each of these were separate and independent provisions capable of being complied with without breaching any of the others. All of the restraints were binding, severally and independently.

As insurance policies are renewed at 12 month intervals, the Court held that a 12 month restraint was reasonably necessary to show the skill and competence of the firm and attempt to maintain a connection with OAMPS' clients. The period provided OAMPS with the appropriate time necessary to protect their legitimate business interests.

The initial decision to restrain the broker from dealing with 17 of OAMPS' clients was upheld. It extended to clients the broker had dealt with previously but was not dealing with at the time of his resignation. The broker was found to be highly competent and deeply experienced, likely to create a real connection with clients if he dealt with them by reason of those attributes.

Total RISC Technology Pty Ltd v Cannings & Anor

IT company Total RISC Technology could not restrain an employee from working for another company in a 'similar' field after the Court found that the other company was not a direct competitor.

After the employee, an International Program Manager, resigned and started working for Interactive Pty Ltd, Total RISC Technology attempted to enforce a restraint clause contained in the employment contract which stated:

For a period of 6 months after termination of the employee's employment with TRT, the employee will not alone or together with any other person, whether as principal, agent, directly or indirectly carry on or be engaged, concerned or interested in or otherwise associated with any trade or business which directly competes with TRT.

The Court found that the restraint from engaging in "any trade or business which directly competes with TRT" referred to the classification of an activity, or activities, not to the identity of an employer. It stated that it was not enough to show association with a company which competed with Total RISC Technology, but rather that a breach could only be found if there had been engagement in a trade or a business which directly competed with Total RISC Technology.

The activity of Interactive as a whole was not the trade or business which was to be examined and classified. Instead, it was the trade or business of the area of Interactive in which the employee now worked. The Court determined this to be Interactive's Business Services Group and provision of managed services.

It then considered whether that trade or business directly competed with Total RISC Technology. In considering the meaning of 'directly competes', the Court said that it was not enough that Total RISC Technology and Interactive were in competition. In assessing whether a business directly competes with another business, the primary focus is on the perception of the customer, and any influence which the services available from one side or the other have on the customer's decisions about where to place their business.

While the Court held that there was not a high degree of differentiation in the end product of each business, the manner of delivery and resources required were sufficient to differentiate them in this case.

BDO Group Investments (NSW-Vic) Pty Ltd & Ors v Ngo & Ors

Two directors of accounting firm BDO were recently prevented from leaving to work for a rival firm after interlocutory orders were made enforcing employment and contractual restraints against them.

In 2009, the directors entered into a Sale Agreement, Unitholders Deed and Employment Agreement as part of a deal that merged BDO Kendalls in Victoria with BDO practices in NSW and the ACT. They became directors of the combined BDO Group and received a share of the $75 million sale price, which was paid entirely for the goodwill of the Victorian business. They both later gave notice of their resignation, intending to join a rival organisation.

BDO sought to enforce restraints contained in the three agreements, which each contained various restraints directed at preventing competition and the solicitation of BDO Group clients. The restraints in each of the agreements varied in length from three months to five years. BDO argued that the restraints had been put in place to protect the value of the goodwill it had purchased from acts of 'destructive competition'. The employment contract required the directors to give two years notice if they resigned before June 2014.

The directors argued that the restraints went beyond what was needed to protect BDO's legitimate interests and that the notice period was "harsh, unjust and unfair".

The Court accepted that, while the law was generally opposed to restraints of trade in employment contracts except in limited circumstances, these considerations do not apply where parties have equal bargaining power and enter into a contract for the sale of goodwill.

The Court found that the interrelationship of the three agreements the directors entered into made it very difficult, and possibly quite inappropriate, to treat the provisions of the employment contract in isolation. In the context of the sale of a business, the approach of the Court was, essentially, based on commercial fairness and the need to uphold parties to the bargain which they have made.

The directors alleged that they would suffer hardship if prevented from pursuing careers with the rival company. However, BDO offered to continue to pay the directors their full entitlements during the notice period and give them the option of working.

The Court found in favour of BDO, preventing the directors from resigning and joining a rival firm until a full trial of the matter.

For more information

HopgoodGanim's Industrial and Employment Law team can assist by:

  • drafting restraint of trade provisions with maximum potential for enforceability;
  • advising about the extent to which, if at all, non-compete obligations imposed on a prospective new employee are likely to be binding or impact on their proposed employment with you;
  • helping you to manage the departure of departing employees so as to maximise your ability to protect your business goodwill and other legitimate interests;
  • developing strategies to manage the obligations of new employees who bring non-compete obligations with them, with a view to avoiding disputes; and
  • prosecuting or defending proceedings to enforce restraint obligations or protect your confidential information.

For more information about restraint of trade provisions, please contact HopgoodGanim's Industrial and Employment Law team.