Restraint of Trade Article

Restraint of trade clauses are commonly used by businesses (employers) to protect their business interests from being sabotaged by former (or in some cases current) employees.  

We have noticed that employers are commonly including restraint of trade clauses in their employee’s contracts without first seeking legal advice. You can imagine an employer’s displeasure when they seek legal advice (normally at the time of enforcement, when it is too late) and are told that the restraint of trade clause they seek to rely upon is unenforceable and their trade secrets, confidential information and goodwill are exposed.

Despite most employers being familiar with restraints of trade clauses, employers are often shocked to discover that restraint of trade clauses are only enforceable to the extent that the restraint is reasonably necessary to protect the employer’s legitimate business interests [1] – with the onus on the employer to prove that.

This raises two questions:

  1. What is a “legitimate business interest”; and

  2. What is “reasonably necessary”?

Legitimate Business Interests

A legitimate business interest may include (but is not limited to):

  1. Confidential information;

  2. Client/customer lists; and/or

  3. Employees.

However, a legitimate business interest may not include the possibility of a former employee competing against the employer. An employer may not prevent a former employee from using knowledge gained during their employment that does not affect a legitimate business interest.

The restraint should expressly state the legitimate business interest being protected, as decision makers have deemed restraint clauses unenforceable in circumstances where they are required to infer what specific interest is being protected.

Reasonably Necessary

As stated above, a restraint of trade clause must go no further than reasonably necessary to protect the employer’s legitimate business interest. In determining what is reasonably necessary, a decision maker will consider all the relevant circumstances as at the time the restraint of trade clause was agreed to and not the time the restraint is sought to be enforced.[2]

In order to determine whether the restraint is reasonably necessary, consideration will be given to the following circumstances (depending on the interest being protected):

  1. The duties performed by the employee in their position within the business;

  2. The former employee’s relationship with clients/customers (that is, were they in a position to gain the trust of clients? Is there a risk that the employee may take the client with them if they leave the business?);

  3. The position of the employee within the business;

  4. The nature of the confidential information;

  5. The nature of the employer’s business;

  6. Will the employer be harmed if the employee is not restrained; and

  7. Any other circumstances that may be relevant to the matter.

Enforcing Invalid Restraints

In our experience, employers quite often have a legitimate business interest that can be protected. However, in protecting their legitimate business interests’ employers often overstep the mark by drafting restraint of trade clauses that go beyond what is reasonably necessary to protect that interest (ironically leaving their legitimate business interests unprotected).

There is no set test used by decision makers to determine whether or not a restraint of trade clause is reasonable. Instead, it depends on the facts and the evaluation of the approach that is reasonable.

In saying that, you can be pretty sure that restraints that include the words “in any capacity” are likely to be declared invalid as they too wide.[3]

The most common remedies sought for breaches of restraint of trade clauses are damages and injunctive relief. The costs associated with litigating these remedies are usually substantial, especially considering that if your action is successfully defended (that is, you are unsuccessful in your action), you may be ordered to pay the costs of the other side.

As such, attempting to enforce an invalid restraint of trade clause can not only be a costly exercise, but may also leave your legitimate business interests vulnerable and exposed.

Takeaways

The importance of seeking legal advice regarding restraint of trade clauses cannot be understated. Their mere inclusion in a contract does not mean that they are enforceable. Restraint of trade clauses are only enforceable when they protect a business in circumstances where an employer can demonstrate that the restraint is reasonably necessary to protect the employer’s legitimate business interests.

If an employer attempts to overreach and extend the restraint of trade clause beyond what is reasonable, the restraint clause is likely to be declared invalid; rendering the clause, in effect, useless.

Employers should also consider the circumstances in which employees gain increased responsibility within a business and their original restraint no longer adequately protects an employer’s legitimate business interests.  As an employee is promoted within a business, an employer should review the employee’s employment contract to ensure that it adequately reflects the employee’s role within the business and reasonably protects the employer’s legitimate business interests.

We strongly recommend that employers seek legal advice prior to including a restraint of trade clause in an employment contract. In the event that you fail to seek that advice you are putting your business at risk.


[1] Linder v Murdock’s Garage [1950] HCA 48 at [6].

[2] Adamson v New South Wales Rugby League Ltd (1991) 31 FCR 242.

[3] Tv Shopping Network Ltd v Scutt & Anor [1998] NSWSC 705


Disclaimer:
Reliance on content the material distributed is general information only. The information supplied is not and is not intended to be, legal or other professional advice, nor should it be relied upon as such. You should seek legal or professional advice in relation to your specific situation.