Restraint of trade clauses are now quite commonly used in employment contracts, but this wasn’t always the case.

A covenant in restraint of trade, also sometimes referred to as a ‘non-compete’ clause, is a term in an employment contract that requires an employee, after leaving an employer, not to perform a particular type of work within a geographical area around the current employer’s place of business for a specified period of time.

Traditionally, employers weren’t able to include covenants in restraint of trade in their employment contracts as it was considered contrary to public policy. The law has developed over the years to recognise these clauses as valid, provided they are justified in the circumstances, particularly to protect the employee’s legitimate business interests. It is now well established that an employer may impose restraints on their ex-employees, directed at protecting the goodwill of the business following the employee’s departure. 

The employer must demonstrate that, at the time of the agreement regarding the restraint:

• The restraint is required to protect the employer’s legitimate business interests, such as confidential information, goodwill, a stable workforce, customer connections, or commercial interests; and
• The restraint includes no more than is reasonably necessary to protect those interests.

When considering what should be included in a non-compete clause, the basic question is: what is the employer seeking to protect? Common reasons for inserting a non-compete clause are to ensure that employees do not take up employment with a competitor or set up a rival business.

Is the covenant in restraint of trade reasonable?

Whether the restraint is reasonable will be judged at the time the contract is made, in light of all of the surrounding circumstances, including the length of the restraint, the geographical area over which the restraint is to operate and what the employee is being restricted from doing.

Courts are more likely to uphold restraints regarding customers, clients, employees and confidential information, and less likely to uphold restraints against ‘competition’ (e.g. working for a competitor.) A ‘non- compete’ restraint which serves no further purpose than to prohibit employees from working with a rival organisation are unlikely to be enforceable, as this is contrary to public interest.

The circumstances of how the employment contract was terminated will also be relevant in assessing the reasonableness of the restraint clause.  For example, if an employee is made redundant following a company restructure, a non- compete clause maybe held to be unreasonable.

The general factors a court will assess in determining the reasonableness of a particular restraint of trade clause include:

• The nature of the ‘protectable’ interest that is the subject of the agreement;
• The duration of the restraint;
• The extent of the restraint; and
• The relevant bargaining power of the parties at the time of entering into the agreement and whether, as a result, it would be unconscionable to enforce the restraint.

Let’s consider some of the most common forms of covenants in restraint of trade and when they will be considered legitimate vs. when they will be considered unreasonable.

The different types of covenants in restraint of trade

• Competition

  A restriction on an employee to work for a competitor must protect a legitimate interest in the employer’s business or the goodwill of the business. An employee restraint will not be upheld if it is only for the purpose of preventing an employee applying their personal skills and knowledge which may have been acquired during their course of their employment. This reflects the principle that a person should not be readily excluded from earning a living. It would be excessive for instance, for a covenant to simply prevent the employee to work for a ‘competitor’ or a particular ‘business’ rather than specify the particular activities they are restrained from doing. A restraint preventing an employee from carrying on ‘the business or profession of a lawyer’ within a 10km radius of the business premises is an example of a restraint that would be considered unreasonable.

  If an employee has a level of seniority, which may translate into the employee having a close relationship with important clients, this may be sufficient to warrant a purely non- competition clause. In these circumstances, something more than mere contact between the employee and the business’s clients/ customers is required, it must be a relationship of a kind which would influence a customer’s decision to give his or her business to a competitor for whom the former employee now works.

• Clients

  Some types of businesses are more likely to have ongoing relationships with their clients or have repeat clients. These businesses are more likely to warrant protection with the use of a non-compete clause, rather than say the type of business which usually has one off or less regular transactions with clients (e.g. an accountant vs. a real estate agent.) Whether an employee is the human face of the business, has regular control over client(s) business or could potentially foster a special relationship with the client(s), will be taken into account when considering the validity of a restraint of trade clause in relation to clients.

  This is distinct from a non-solicit clause, which is the contractual undertaking by an employee not to solicit customers from their former employer. These types of clauses will be readily upheld.

• Confidential Information

  Generally, an employment contract will contain express provisions regarding an employee’s use and disclosure of confidential information both during and after employment. The misuse of confidential information has the potential to significantly damage the organisation which owns the information and therefore restraints of this nature will be valid if the covenant is for the purpose of reasonably protecting an employer’s business interest. Some kinds of information will be obviously confidential (such as client lists, price lists, market research data etc.) however sometimes it is not so clear cut. An employee will inevitably acquire knowledge as part of performing their employment duties (or for example attending training courses) and it may become difficult to restrain information which is now contained in the employee’s head and forms a part of their skill set. For this reason, employers should be very specific of what they consider confidential information and avoid drafting vague ‘cover all’ clauses such as ‘all business-related information’ is confidential, as this is likely to be unenforceable.

  Where no such clause is included, the extent to which information is subject to a duty of confidentiality will be determined in light of all the circumstances in which the information was acquired and subsequently used.

  In assessing the restraints on disclosing confidential information, the following factors may be considered (though this is a non-exhaustive list):

  • The extent to which the information is known outside the business;
  • The skill and effort expired to collect the information;
  • The extent to which the information is treated as confidential by the employer;
  • The value of the information to competitors;
  • The ease or difficult with which the information can be duplicated by others;
  • Whether it was made known the employee that the information was confidential; and
  • Whether the usages and practices in the industry support the confidentiality.

  If the scope of the information seeking to be restricted is too wide, the range may be narrowed. For example, the requirement that “all business relating to the business of the company and its customer and employees” would be considered too wide for what is reasonably necessary to secure an employer’s business legitimate interests. This will be considered in relation to the advantage a competitor would have if they had access to the information. If the information is operating in a relatively small market then it will be more likely to be an advantage to a competitor.

• Other Employees

  The employees of a company are generally viewed as being of intangible value and therefore inherently comprise part of the business’s goodwill.  It is for this reason that a restraint that seeks to prevent ex-employees from soliciting employees of their former employer will constitute a legitimate business interest, as a stable workforce needs protecting.

Gold and Platinum Members read on for tips for effective Non-compete clauses.

Look out for Part 2 of this Bulletin that deals with statutory protections available to employers.

Build these documents now:

• Employment Contract
• Independent Contractor Agreements
• Webinar Recording - Employee V Contractor 
• Confidentiality Agreement (Non Disclosure) 
• Employment - Conduct Issue Letter 
• Employment - Employee Expenses Policy 
• Employment - Performance Issues Letter 
• Employment - Request for Medical Information 
• Employment - Termination Letter 
• Employment - Transferring Employee Letter