Restraints of Trade

Restraints of trade

A contract can be in restraint of trade if one party (“the covenantor”) agrees with another party (“the covenantee”) to restrict the covenantor’s liberty in the future to carry on trade with other persons not party to the contract.

The most common restraints of trade are:

  • “non-solicitation” clauses preventing a covenantor from soliciting, or accepting, work from clients of the covenantee’s business;
  • “non-poaching” clauses preventing the covenantor from soliciting employees from the covenantee’s business;
  • “non-compete” clauses preventing the covenantor from, directly or indirectly, competing with the covenantee’s business; and
  • “non-disclosure (confidentiality)” clauses preventing the covenantor from disclosing specified information relating to the covenantee’s business (this is also protected at common law and in equity by way of a general prohibition on unauthorised use of trade secrets and other information of a confidential nature).

Basic Principles / Law

A restraint of trade is presumed to be void.  The presumption can however be rebutted if the restraint is justified.

In practice, the law operates as follows:

  • First, there must be a restraint of trade;
  • Second, the restraint must relate to a protectable interest. Examples of protectable interests recognised by the Courts include goodwill, trade secrets, covenantee’s staff, confidential information and customer and client bases;
  • Third, the party seeking to enforce the restraint must demonstrate that the scope and duration of the restraint is reasonable as between the parties;
  • Lastly, even if the restraint is reasonable as between the parties, a person will be released from the restraint if he or she is able to show that the restraint is unreasonable having regard to the public interest.

Reasonableness

Whether or not the restraint of trade is reasonable must be judged based on the circumstances existing at the time of entry into the contract (not at the time it was breached).

In considering the scope of the restraint, the Court looks for a definite connection between the restraint and the covenantee’s business, trade or profession.  If the restraint goes beyond the covenantee’s business, it will almost invariably be unreasonable by reason of its breadth.  Three things are considered:

  • if relevant, the geographical area covered by the restraint clause;
  • the duration of the restraint (the longer the restraint, the less likely it will be reasonable); and
  • the acts covered by the restraint – what the covenantor is restrained from doing and whether the covenantor must refrain from doing all the acts referred to for the covenantee to be adequately protected.

Restraints of Trade in Sale of Business

In a sale of business contract, the sale of the goodwill provides a justification for, and a measure of, the enforceability of a restraint.  If the restraint is not connected to the sale of the goodwill it will likely be struck down.

This was illustrated in Freedom Finance Accounting Pty Ltd v Goldstein [2017] VSC 179.  Freedom Finance Accounting Pty Ltd entered into an agreement to acquire accounting firm Farrell Goldstein.  After completion, Mr Goldstein continued to work for the accounting firm.  Mr Goldstein was restrained by the contract for up to 3 years post completion of the sale of the business within 100 kilometres.  Sometime after (within the 3 year period), Goldstein resigned from his employment and sought to continue to provide accounting services to clients whom he previously serviced as an employee of the firm.  The plaintiff sought an injunction to prevent this.  In this case it was held that the restraints were unenforceable.  The reasons included that the restraints afforded protection beyond the goodwill of the accounting business acquired and that the offending provisions could not be severed.

Restraints of Trade in Employment Agreements

Employment contracts are subject to a stricter approach than contracts for the sale of a business.  The approach to be taken is as follows:

  1. The protectable interests of the employer must first be identified. The nature and geographical spread of the employer’s operations, the location of clients and the goodwill of the business will be relevant.
  2. The status, functions and duties of the particular employee must be identified. The degree of contact between the employee and clients, the employee’s seniority and responsibility, and possession of (or access to) trade secrets and confidential information will be relevant.
  3. In the light of items 1 and 2 above, it must be decided whether the particular restraint imposed goes no further, and extends no longer, than is necessary to safeguard the employer’s protectable interest.

Cascading Clauses

Courts have the capacity to sever restraint clauses they find to be unreasonable.  Except for New South Wales (where specific restraint of trade legislation applies), severance is usually only possible where the provision contains a series of overlapping restraints, known as “cascading” restraint clauses.  Cascading clauses present a cascading set of variables in time, distance and subject matter.  A well drafted clause of this type presents parties with a range of options that could be considered justified/reasonable, but which can be severed if a Court deems necessary.  A poorly drafted clause may present too many options capable of being deemed reasonable or may be considered too vague.

Remedies

Remedies for a breach of restraint of trade include the following:

  • Financial damages and compensation for the breach.  In accordance with the general principles of contract, a covenantee must be able to prove that they have suffered loss as a result of breach of a restraint of trade.  Where damages may be an adequate remedy, the Court may be reluctant to grant an injunction (see below).
  • Court injunction to restrain the covenantor from acting in a certain way or continuing to act in a certain way.  In deciding whether to grant an injunction the Court will consider any period of unexplained or unreasonable “delay” by the employer in bringing a claim for an injunction.  The usual equitable discretions for the grant of an injunction are:
  1. Is there a prima facie case?
  2. Are damages adequate?
  3. Would hardship be caused by the grant of an injunction?
  4. Does the balance of convenience favour the granting of the injunction?
  • Seek an “account of profits”.  The covenantee may be entitled to the trading profits earned by the covenantor.

Fletcher Law has solicitors experienced in preparing contracts containing restraints of trade, including business sale agreements and employment agreements as well as in disputes concerning restraints of trade.  Please contact us if you require legal advice.

The content of this publication is for guidance purposes only.  This content does not constitute legal advice and should not be relied upon as such.  Legal advice about your specific circumstances should always be obtained before taking any action.

 

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