Business owners, in an attempt to protect the goodwill of their business will often include ‘Restraint of Trade’ provisions in employment agreements, partnership agreements and sale of business agreements. ‘Standard’ clauses are often used instead of tailoring a clause to suit the specific circumstances. In the last six months alone, there have been at least half a dozen cases in Australia dealing with restraints and whether or not they can be enforced. All of the cases highlight the importance of getting the wording right or risk losing the benefit of such a clause.
What are ‘restraint of trade’ clauses?
They are a means for employers and partnerships to prevent departing employees or partners from taking clients or competing with the business for a period of time after they leave. They can be very important particularly for businesses that rely on client relationships.
Restraint of trade clauses are also used by people buying a business to stop the seller from starting up a competing business immediately after the sale.
Usually the courts will be less likely to uphold a restraint between an employer and employee than one preventing a seller setting up in competition. This is because an employee restraint is effectively preventing an employee from working in his or her chosen field whereas a restraint in a business sale agreement can benefit both the seller and purchaser. It can benefit the purchaser by restraining the seller from competing with the purchaser after the sale and it can benefit the seller as the giving of a restraint often increases the value of what is sold.
What are the risks?
Courts will usually only enforce restraint clauses if they are ‘reasonable’. In New South Wales, the Restraints of Trade Act 1974 allows a court to ‘read down’ the terms of a restraint clause to modify it, for example to the time period or geographic area, until it is reasonable.
However in other states and territories, the courts do not have this discretion. Therefore if a restraint clause is not ‘reasonable’ then a court will usually find the whole clause to be void and unenforceable. This is why you often see restraint clauses with ‘cascading’ provisions that cover a number of alternatives. For example, the clause may say that the restraint is for one, two or three years and cover Brisbane, Queensland or Australia, whichever is reasonable. This allows a court to pick whichever scenario is ‘reasonable’ and avoid the whole clause from being held unenforceable.
What is reasonable?
In deciding whether a restraint is reasonable, the courts will look at whether the restraint protects a genuine interest of the restrainer and whether the time period and geographical area are no greater than required to protect that interest. The results of some recent cases are:
NSW Shareholder Restraint
Austress-Freyssinet sought to restrain its former managing director and shareholder, Mr Kowalski from exercising any rights as a director and shareholder of the company he subsequently joined, NT Pre-Stressing, which was engaged in the same type of business as Austress. The restraint clause was in a shareholders agreement. The restraint prevented Mr Kowalski from being involved, which included being a shareholder, in any business which was the same or similar to Austress, was unlimited as to geographic area and included three alternative time periods of three years, two years and one year. In this case it was found that:
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Genuine Interest: the restraint protected a legitimate interest in retaining the value of the business. However the restraint was too broad as it would have prevented Mr Kowalski from being a shareholder in a publicly listed company engaged in a similar business to Austress. Therefore, the judge excluded this part of the restraint from the clause.
Area: an unlimited geographic area was unreasonable as Austress did not operate worldwide. The Judge said that Australia would be reasonable.
Time: a three-year period was reasonable. This was in light of the fact that Mr Kowalski had been with Austress and in that type of business for over 20 years and therefore departure to a competitor could be detrimental to Austress.
WA Employee Restraint
Nomad Modular Building sought to restrain a former employee, Mr Smith, from taking up employment with Australian Portable Buildings (APB) shortly after he resigned from Nomad. The restraint clause in Mr Smith’s employment contract prevented him from being engaged in a competing business and from soliciting or interfering with clients, employees and contractors of Nomad in WA and Queensland for a period of six months. In this case it was found that:
Genuine Interest: Nomad had a genuine interest to protect – it was reasonable to protect its relationship with customers who knew Mr Smith and to protect itself against the loss of employees and contractors who undertook its work. Also the extent of the restraint was reasonable as it did not prevent Mr Smith from working at all, it only prevented him from working for a firm making portable buildings.
Area: the restraint for WA and Queensland was reasonable. Nomad’s main business was in WA but it was planning to establish a business in Queensland and Mr Smith had knowledge of Nomad’s plans and strategy for Queensland.
Time: Six months was reasonable but the judge found it was probably the maximum that could be applied.
QLD Partner Restraint
Mr Rich was a partner of the accounting firm BDO Kendalls. He retired as a partner on 30 June 2005 but then became an employee of the firm for a year until 30 June 2006. Then, Mr Rich took a job as an in-house accountant for a client of BDO. BDO sought an injunction claiming Mr Rich was in breach of the restraint clause in his partnership agreement with BDO. The restraint clause prevented Mr Rich from working for clients of BDO, was unlimited as to area and had a number of alternatives as to time ranging from one year to three years from Mr Rich’s retirement as a partner. In this case it was found that:
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Genuine Interest: a restraint against all clients of the firm was justified and not just the clients Mr Rich acted for as partners share the assets of the firm and its goodwill. Furthermore, the restraint was limited to clients of BDO and therefore Mr Rich could still work and offer his services to many other people.
Area: even though the restraint had no territorial limitation, as the firm only operated in Queensland, which brought its own limitations.
Time: Mr Rich should be restrained until the matter went to trial but, in any event, until 30 June 2009 (being 3 years after he retired) from providing advice to former clients of BDO, including the company he went to work for.
What must you do to ensure a restraint clause can be relied upon?
From the numerous cases that have dealt with restraint clauses, the requirements for a restraint to be held reasonable are:
Genuine Interest: first, to restrain another person, you must have a genuine and legitimate interest that needs protecting and secondly, the restraint should be limited to protecting that interest;
Time Period: the restraint should not be for a time period that is longer than necessary to protect that interest;
Geographic Area: the restraint should not cover a geographical area that is larger than necessary to protect that interest;
For employees: take particular care to ensure that the restraint is not so broad as to prevent the employee form working at all; and
Cascading Clauses: with alternative time periods and geographic areas may help to ‘hedge your bets’.
Therefore it is critical to identify precisely what interests need to be protected and in what area and for what time and then limit the restriction to that. Be wary of any so-called ’standard’ clauses. If they do not suit the specific circumstances, they are likely to be void and unable to be enforced. There is
little point having an agreement in place if you cannot enforce it when necessary.
* The opinions expressed in this article are those of the author, and don’t necessarily reflect the opinions of DYNAMICBUSINESS.com or the publishers.
