Employment contract restraint of trade clauses – What do they mean?
Employers commonly use restraint of trade clauses in an employment contract to protect their business interests. The clauses prohibit the employee from certain conduct during and/or after their employment.
Restraint of trade clauses in employment contracts are covered by common law, which means that there is no legislation that defines and regulates them. Instead, court cases set the law in this area.
However, employment contract restraint of trade clauses can only operate where they don’t interfere with legislation, in particular the Competition and Consumer Act 2010 (Cth).
The Act doesn’t apply to clauses in your employment contract relating to:
- Restrictions on employment
- Restrictions between (business) partners
- Restrictions in a contract for the sale of a business
So restraint of trade clauses are most likely to operate in these areas.
Common restraint clauses
Common clauses restraining you from doing certain things that might be found in your employment contract can relate to:
- Competing business
- Soliciting (taking) the business’ clients
- Poaching or recruiting the business’ staff
- ‘Trade secrets’
When is a restraint of trade clause legally valid?
Courts presume that any clause that imposes restrictions on a person’s freedom to engage in trade or employment is illegal unless it is demonstrated to be reasonable.
This means that a restraint of trade clause in an employment contract will be invalid unless:
- There is a legitimate business interest that requires protection.
- The clause is reasonable in the interest of the parties (it does no more than is reasonably necessary to protect the business interest). The onus is on the party seeking to enforce the clause to demonstrate that it is reasonable.
- The clause is reasonable in the interest of the public (the onus is on the party seeking to strike down the clause to demonstrate that the clause is not reasonable in the interest of the public).
What is a legitimate business interest?
There a wide range of business interests that courts will consider to be legitimate including the protection of:
- ‘Trade secrets’
- Confidential information
- Customer connections
- Staff relationships
What is ‘reasonableness’?
Factors that indicate the reasonableness of a post-employment restraint clause may include:
- The duration of the clause after employment ends
- The geographical area that the clause applies to
- The specific activities or information that is restrained
A clause in an employment contract that seeks to restrain the former employee for a long period of time, over a wide geographical area and for a broad range of activities is less likely to be upheld.
Courts assess reasonableness at the date that the employment contract with the restraint of trade clause comes into force (for example, the date the contract was signed or the first day of employment). They do not assess reasonableness as at the date that the clause is challenged or sought to be enforced.
When determining whether a “solicitation” (taking of clients) has occurred, whether the former employer or the client has made the first contact is not decisive. A restraint of trade clause can’t prohibit a former employee from accepting work from a client of their former employer.
However, the former employee needs to be careful that when they respond to an enquiry by the client, that they don’t cross the line from willingness to work with the client to positively encouraging the client to work with them.
Confidentiality clauses are generally enforceable while the information protected remains confidential. This means that confidentiality clause can potentially be enforced for a much longer time than other types of restraint of trade clauses.
When will a restraint of trade clause be invalid?
A court will not enforce a restraint of trade clause in an employment contract that protects simple competition from former employees.
When a former employee goes into legitimate competition with their former employer, they are also entitled to use any expertise that they acquired in the service of their former employer.
As stated above, clauses are more likely to be struck down if they operate for a long period of time, over a broad geographical area or apply to a wide range of activities.
For example, if a former employee takes up a similar position but with a different scope and target market and only a small proportion of their old role is being performed in the new role, a restraint of trade may not be enforceable against them. This occurred in one case where a court would not enforce a restraint of trade clause where the former employee was only performing 30% of their old role in their new position.
However, in another case, a two-year restraint of trade clause relating to confidential client information was upheld by a court who found that an employee had close and intimate knowledge of management and clients.
If you are wrongfully terminated, all restraint of clauses will be considered invalid. However, you may still be bound by confidentiality requirements. This is because even though the contractual clause may not be enforceable, you will be covered by an ‘equitable’ duty of confidence.
Finally, an otherwise valid restraint of trade clause will only be enforceable if the employment contract that contains the clause still governs the relationship between the employer and former employee at the time the employment ended.
For example, if an employer substantially changed their former employee’s duties without getting the employee’s agreement, a court may decide that the employer has repudiated the contract. This means that the terms of the contract are no longer operative or enforceable against the former employee.
As such, employers should periodically review their employees’ contracts and update them and the restraint of trade clauses as their roles and the business changes.
What happens if the restraint of trade clause is upheld?
If a restraint of trade clause in your employment contract is upheld, the court may:
- Impose an injunction to stop a breach or continuing breach of the clause by the former employee.
- Make an order for compensation to the former employer.
- Make an order to recover profits resulting from the breach.