Protecting what you've built: Restraints of trade in business and employment

Whether you are selling a business you have spent decades building, acquiring one, or managing a team of senior executives who hold your most valuable client relationships, few legal tools are more important (or more frequently misunderstood) than the restraint of trade covenant.

Done well, these provisions protect goodwill, confidential information, and competitive advantage. Done poorly, they are worth no more than the paper they are printed on. Understanding why requires a brief look at the law.

The starting point: Restraints of trade are presumed invalid under Australian law

Australian courts start from an uncomfortable position for those seeking to enforce restraints: they are presumptively void. The common law treats restrictions on a person's freedom to work or trade as contrary to public policy unless they can be justified. As the High Court confirmed in Geraghty v Minter (1979) 142 CLR 177, a restraint will only be upheld if it is reasonable as between the parties, meaning it protects a legitimate interest and goes no further than is necessary to do so, and is not contrary to the public interest.

Reasonableness is assessed across three dimensions: the scope of activities restrained, the geographic area covered, and the duration of the restriction. A restraint that is excessive in any one of these dimensions is liable to fail, sometimes entirely.

Courts may, in appropriate cases, "read down" an overreaching restraint to what is reasonable, or sever an unenforceable clause from one that can stand. This has given rise to the common practice of drafting "cascading", "waterfall" or “cocktail” clauses, specifying multiple decreasing periods (e.g., 24, 18 and 12 months) and geographic areas (Australia, Queensland, greater Brisbane) or combinations of both, with the intention that the court will identify the highest acceptable combination. Whether this approach achieves its purpose depends heavily on how the clauses are constructed and on the facts at hand.

Employment restraints: Heightened scrutiny and limited protection

In the employment context, courts apply what the High Court in Geraghty v Minter described as a "stricter and less favourable" standard than in commercial agreements. This is because an employee has bargaining power that is typically inferior to an employer's, and their ability to earn a living is directly at stake.

An employer cannot use a restraint simply to prevent competition. The legitimate interests capable of protection are narrower: principally the employer's trade secrets and confidential information, and client and customer connections built through the employment relationship. Restraining a former employee from using general skills and knowledge they have acquired over a career will not suffice.

What this means in practice: A business owner seeking to impose a restraint on a departing senior executive needs to identify, with precision, what they are actually protecting. A Chief Financial Officer who holds detailed knowledge of pricing strategy, supplier contracts, and financial modelling presents a genuine case. A mid-level manager with no client-facing role and no access to genuinely confidential information does not.

The courts have not been kind to employers who overreach. In AEI Insurance Group Pty Ltd v Martin (No 4) [2024] FCA 1110, a 12-month restraint on competition and client solicitation against a departing executive was closely scrutinised, with the court granting relief only after careful assessment of whether the legitimate interests asserted were genuinely at risk. In 2nd Chapter Pty Ltd v Sealey & Ors (No 2) [2024] VSC 672, relating to the sale of business transaction, the Victorian Supreme Court declined to enforce a suite of restraints, in part because the prohibition on dealing with clients extended to all clients of the business, not merely those with whom the restrained individuals had personally dealt. The scope was simply too wide.

Sale of business restraints: Greater latitude for protecting purchased goodwill

When a business changes hands, the legal landscape shifts, but only partially in the seller's favour.

Courts have long recognised that a purchaser of a business pays not just for its assets, but for its goodwill, which includes the customer relationships, reputation, and ongoing trading advantage that belong to the business. Without a restraint on the seller, those intangible assets can evaporate overnight if the seller simply reopens next door and invites their old clients to follow. Protecting goodwill is therefore a recognised legitimate interest that justifies a more substantial restraint than would ordinarily be tolerated in employment.

As a consequence, restraints in sale of business agreements are evaluated with somewhat greater latitude on duration and geographic scope. A three-to-five-year restraint is not unusual, and courts have upheld restraints covering an entire industry sector within a defined territory, where the scale of the business and the goodwill acquired justified it.

But recent decisions have made clear that this latitude has limits. In 2nd Chapter Pty Ltd v Sealey, the court's close scrutiny of scope and duration in a sale of business context and its willingness to find the restraints unenforceable despite an acknowledged legitimate interest in protecting acquired goodwill, signals that buyers should not assume that a sale context provides a blank cheque. A five-year restraint was found unreasonable in circumstances where the restrained parties held only minor equity stakes in the vendor entity. The connection between the interest being protected and the burden of the restraint must still be proportionate.

Practical implications: Three stakeholder perspectives on restraints of trade

1. The business owner imposing restraints on senior employees

Your senior people know your clients, your margins, your strategy, and perhaps your weaknesses. When one leaves for a competitor (or to start their own operation) the exposure can be significant. A well-drafted employment restraint, supported by appropriate confidentiality obligations, provides both a practical deterrent and a basis for urgent injunctive relief if the worst occurs. The key is tailoring - the restraint must match the actual risk, which varies considerably between a Chief Executive who has personally cultivated major client relationships over many years and a business development manager hired eighteen months ago.

The proposed reforms currently before the Federal Parliament (which contemplate limiting or abolishing non-compete clauses for many categories of employees) will, if enacted, change this landscape materially. Business owners should review their arrangements now, not after the legislation passes.

2. The buyer of a business

You are acquiring goodwill. You are paying for it. Protecting it through an appropriately framed restraint on the seller and on any key managers who are also vendors or who hold equity is a fundamental part of the transaction structure. In negotiating those terms, precision matters more than breadth. A restraint calibrated to the seller's actual sphere of influence and knowledge, at a duration proportionate to the time needed to bed down customer relationships, is far more likely to survive challenge than one that simply seeks the longest and widest restriction that can plausibly be drafted.

Consider also whether key employees, not just the vendor, need to be restrained. If the value of the business lies in a handful of relationships that walk out the door when certain people leave, those relationships need to be addressed in the transaction documentation, not assumed to follow automatically.

3. The seller

This is the perspective least often discussed, but arguably the most important for private clients. When you sell a business, particularly one built over many years, you are likely entering the most significant financial transaction of your life. The restraint you sign may prevent you from working in your chosen field for three, four, or five years. It may prohibit you from approaching former clients or colleagues. Before signing, you should understand precisely what you are agreeing to and whether it is enforceable as drafted. An overreaching restraint that could be set aside by a court may be less concerning than it appears; one that is precisely calibrated and legally sound may be more binding than you anticipate.

Sellers should also be alert to the interaction between restraint terms and earn-out provisions. If your post-completion payout depends in part on business performance, and your ability to contribute to that performance is constrained by the very restraints you have just signed, the interplay needs careful analysis before execution.

Avoiding litigation risk: Why getting the drafting right matters

Restraint of trade law is an area where the gap between a well-drawn clause and a standard template can be the difference between effective protection and an expensive injunction application that fails at the first hurdle.

Careful drafting considers the specific role and access of the person being restrained; the nature and reach of the legitimate interest being protected; the appropriate duration and geographic scope in light of actual competitive conditions; the cascading or cocktail structure needed to maximise prospects of partial enforcement; and the interaction with confidentiality, intellectual property, and earn-out provisions.

Courts do not assist parties who have overreached by rewriting their agreement into something reasonable. They may sever what cannot stand, but only if what remains is coherent and self-contained. The benefit of thoughtful drafting, informed by current case law and by an understanding of how courts in your jurisdiction approach these questions, is that you are not relying on judicial goodwill to salvage something that should have been right from the outset.

Whether you are structuring an employment agreement for a new executive hire, negotiating the terms of a business acquisition, or considering what you are committing to as a seller, advice at the drafting stage, rather than in the courtroom afterwards, remains the most valuable investment in this area of the law.