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What is an enforceable restraint of trade clause?

An Overview on Restraint of Trade

Whether a restraint of trade clause is enforceable, is commonly subject to legal disputes and judicial decision making. An enforceable restraint of trade clause should protect legitimate interests, and not be too wide in its length of the duration or restraint of proposed activities and areas.

In this article, we address the frequently asked questions that local Australian businesses, employers, or employees may ask about restraint of trade clauses. The questions include:

What is an enforceable restraint of trade clause?

The Competition and Consumer Act 2010 (Cth) does not limit the operation of restraint of trade clauses. However, under case law, restraint of trade clauses are presumed invalid. Therefore, when assessing the operation of a restraint of trade, an employer must show to the Court:

  • there are legitimate interests on imposing a restraint; and
  • the scope of the restraint must be no wider than is reasonably necessary to protect that interest.

The common types of enforceable restraint of trade clauses generally found in an employment agreement, include restraining from:

  • working in competition with a former employee;
  • soliciting or attempting to solicit clients from your former employer; or
  • inducing or attempting to induce workers in your former employer, to work with you at your new employer.

Read More: Restraint of trade clauses are common in an employment context. We generally explore the difference between employees and independent contractors in our legal topic, “How to identify an employee or contractor?“.

Why are legitimate interests important to a restraint of trade clause?

Whether there is a legitimate interest will generally be based on: whether there is confidential information that should be protected, and whether an employee has had contact with the employer’s clients and the extent of that contact.

If both questions are answered in the positive, then the restraint is not a mere covenant against competition, but also directed to securing reasonable protection of the employer’s business interest.

How are legitimate interests relevant?

When considering a restraint of trade clause, the clause should be reasonably necessary to protect legitimate interests. If there is not a legitimate interest or it is not reasonably necessary, then the clause will likely be invalid or not enforceable.

Examples of judicial decisions decided in the Victorian Supreme Court on validity, include: Birdanco Nominees Pty Ltd v Money (2012) VSCA 65 and Wallis Nominees (Computing) Pty Ltd v Pickett (2013) VSCA 24.

In Birdanco Nominees Pty Ltd v Money (2012) VSCA 65, a restraint of trade clause was held to be valid. The dispute involved a former employee (as a trainee accountant). The former employee then ceased working and commenced working with a major client of the firm.

The Court held that (3) years was valid, because:

FactorsSummary
Legitimate InterestThere was a legitimate interest to protect with the former employer, namely, the connection they hold with their clients.
ServicesWhile the former employee was not a qualified accountant, the accounting services provided were under the supervision of a qualified accountant and an accountant-client relationship could be built.
DurationThe duration was not unreasonable in consideration of context.

Whereas in Wallis Nominees (Computing) Pty Ltd v Pickett (2013) VSCA 24, a restraint of trade clause was held to be invalid. The dispute involved an information technology consultant and their former employer, that included a twelve-month duration.

The court held that twelve (12) month duration was invalid, because the kind of relationships developed by the employee was not the kind that could provide an opportunity for a close connection and exploitation of relationships.

When is the scope of a restraint of trade too wide?

Whether or not the scope of the restraint is too wide will generally depend on a number of factors. Two relevant questions are:

FactorsQuestions
DurationWhat is the duration of the restraint of trade clause?
Activity and AreaWhat are the activities and area that the restraint of trade clause prohibits?

In answering these questions, the following Australian and United Kingdom cases are briefly explored:

What activities and areas are prohibited?

If an area or activity proposed to be prohibited is too wide, then the restraint of trade may be found to be invalid.

When is a restraint of trade too wide?

An example a restraint of trade being found invalid was Commercial Plastics v Vincent [1964] 3 All ER 546. In this case, a UK manufacturer of thin PVC calendared sheeting had a restraint of trade clause restricting competition with any competitors in the PVC calendaring field.

The Court held that the clause was not enforceable because there was no geographical limitation as the restriction was world-wide, and that the protections of the restriction covered the whole PVC calendaring fields, rather than to the specific activities that involved the employee.

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What is reasonable duration?

If the duration is reasonable, then clause will be valid. However, whether or not a duration is reasonable depends on the facts and issues. Two judicial decisions address the issue of duration, and how the facts and issues shape whether duration is reasonable.

When is duration reasonable?

Whether a duration is reasonable depends on the factual and issues of a circumstance. In Western Australia’s Supreme Court of Appeal decision, Smith v Nomad Modular Building Pty Ltd [2007] WASCA 169, six months was held to be valid. The judicial reasons, included that:

  • the former employee was a senior employee;
  • the former employee’s remuneration was significant; and
  • the area of the geographical area was not unreasonable.

Furthermore, in the Federal Court of Australia’s decision of Pearson v HRX Holdings Pty Ltd (2012) 293 ALR 554, the Court held that a two-year duration was valid, and included judicial reasons that:

  • the former employee was the chief operating officer of the company,
  • the former employee was prominent in his field,
  • there was not unequal bargaining power during the employment negotiations; and
  • the clause reasonably accommodated the contractual cycles that the company operated.

What should be considered when preparing an enforceable restraint of trade?

If you are an employer, we recommend that you should:

  • inspect the express terms of your existing written contracts, in particular, your restraint of trade clauses, and consider the impact that the clauses might have on you, your staff and your business; and
  • if you do not have agreement or contract, seek legal advice on the drafting of your restraint of trade clauses to ensure that the clauses are reasonable in scope and can protect your legitimate business interests.

Notes and Further Information

Other related topics relating to contracts, agreements, and enforceability, in connection with restraint of trade clauses that may form part of a contract or agreement, include:

Independent Contractor or Employee (Identification) |

Do you need legal advice? Call us on (03) 5331 1244 to get in touch and arrange an appointment with one of our lawyers.

You can also connect with us by filling out your details and telling us about your information for legal advice below:

Contact Form

Authored by:
Ben Franklin, Managing Partner (LIV Accredited Specialist – Property Law), &
Matthew Tran, Lawyer.

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