Have you ever considered what might happen if your star employee leaves and takes your business with them? If you don’t have the right contracts in place, you’re risking just that.
Picture this, Stephanie sets up a business with two of her friends, Jayne and Cheryl. Stephanie’s business has grown in two years into a national business employing over fifty employees. One day Cheryl, terminates her employment and within two months is in contact with Stephanie’s major clients and decides to set up a competing business. Within six months, most of Stephanie’s competitors and staff have moved to Cheryl’s thriving business and Stephanie’s once profitable and highly successful business is forced to shut its doors. This may seem unfair, however, without properly drafted employment contracts this is a real reality.
If you risk losing business in the event that your key employees leave, I strongly recommend that you consider including well drafted restraint of trade clauses in all employment contracts.
Without a restraint of trade clause, when an employee quits, they can basically walk out the door and canvas clients and customers and set up a competing business. Now is the time to review your business practices and ensure all employees have properly drafted employment contracts, because if you don’t there may be no business to protect.
While employees are employed they are bound by the common law duty of fidelity and good faith. This duty applies during the course of the employee’s employment, but becomes limited after termination.
Employers must attempt to bind an employee from the outset of the relationship. There is no hard and fast rules that employers can follow to ensure that a restraint of trade covenant will be held to be reasonable.
The general rule is that a restraint is only enforceable if it is “reasonable”. A court will balance the employer’s desire to protect their legitimate proprietary interest with public policy considerations, which protects a person’s right to earn a living in whatever lawful manner they chose. Each case is considered on it’s own facts and circumstances.
The onus of establishing that a restraint is reasonable as between the parties lies on the person seeking to enforce the restraint. The onus of establishing that the restraint is contrary to public interest lies on the person seeking to validate the restraint.
The Restraint Clause
The restraint of trade clause should include:
- The extent of the restraint on an employee’s activities;
- The geographical area within which such activities are restricted; and
- The duration of such a restraint.
All of which must be reasonable having regard to the individual employer’s need to protect it’s legitimate business interest.
Employers need to provide instructions about the particular interest they seek to protect and the proper identity of the party whose business is being protected.
The court gives considerable weight to what parties have negotiated in their contracts, but a contractual consensus cannot be regarded as conclusive, even where there is a contractual admission as to the reasonableness. The validity of the restraint is to be tested at the time of entering into the contract and by reference to what the restraint entitled or required the parties to do rather than what they had intended to do or have actually done.
In New South Wales, the common law principles have been modified by the operation of s 4(1) of the Restraint of Trade Act which provides: “A restraint of trade is valid to the extent to which it is not against public policy, whether it is in severable terms or not.” What this means is that the Act allows the severance of an excessive and unreasonable restraint to the extent that it goes against public policy. For example, if a restraint of trade clause provides that an employee is restrained for a period of twelve months, the Act allows the court to read down the term to ensure it is not against public policy and reduce it to six months if this is what the court deems reasonable in those particular circumstances.
Enforcing a restraint
An employer has a right and should protect itself by taking injunctive steps against any employee who has not complied with the restraint provisions in a contract. An employer must obtain interlocutory relief, however, the court will only award the interlocutory injunctive relief if certain criteria is satisfied and that the employer gives an undertaking as to damages. An undertaking as to damages means that the employer must pay the other side’s damages and costs should the injunctive proceedings fail.
The employer must establish a sufficiently arguable case for a final injunction having regard to the balance of convenience. The court must determine the reasonableness of the restraint of trade provision and show that it is for the protection of the legitimate business interest of the employer.
In the Victorian Supreme Court, the court refused to enforce an Australian-wide post employment restraint on a lighting salesperson as the reference to “anywhere in Australia” was too wide to be enforced.
In the New South Wales, the enforceability of a six month post termination restraint was imposed on a real estate agent as the Court considered that the clause was reasonable in it’s geographic restriction of 20 kilometre radius from the real estate business.
In another recent New South Wales Supreme Court matter, Justice Young confirmed that an employee cannot remove, whether by using paper or memory, a material part of the former employer’s business records, but the employee can approach a particular client or customer whom the employee can recall without a list or deliberate memorisation. It is not enough to have evidence that the employee possesses specific and unidentifiable confidential information to ensure a restraint of trade is upheld. There must also be evidence that disclosure of that information to a competitor would damage the employers interest.
1. Ensure each employee has an individual employment contract with restraint of trade provisions.
2. Avoid using boilerplate (precent type) restraint of trade clauses.
3. Ensure that employment contracts are tailor-made to the specific employee.
4. Ensure the restraint is reasonable having regard to the employer’s need to protect its legitimate business interest.
5. When seeking to enforce a restraint, they need to be able to point to a specific and identifiable loss.
To maximise the chance of enforceability, in employment contracts outside New South Wales, it is prudent to utilise waterfall or ladder clauses, which provide for progressively narrower restraint areas and progressively shorter lengths of time, so that if the broadest parameters of the restraint exceed what is reasonably enforceable, severance according to the terms of the contract can create a narrower or shorter valid restraint.
It is always important to bear in mind that cases involving restraint of trade relying heavily on the facts at issue and it is dangerous to draw general conclusions. My advice for all employers is to act now. It is simply too late to seek to enforce a restraint if there is no employment contract or, in my view, too difficult to enforce the common law duty of good faith and fidelity where there is no evidence that the employer has removed a material part of the former employer’s business records.
Matthew Hourn is a partner with Clinch, Long Letherbarrow Lawyers (www.clinchlongletherbarrow.com.au) in North Sydney.