By Mark Petrucco and Megan Scott
Restraint of trade clauses are found in business sale agreements, shareholders’ agreements and employment contracts. In most cases the restraint clause will come into effect on execution of the sale agreement. However in some cases the clause will come into effect after the particular relationship ends. The restraint clause prohibits the vendor of the business, the former shareholder and/or the former employee from certain conduct or activity (such as solicitation of customers or former work colleagues) and depending on that person’s role the restraint will operate for a period of time and possibly within a geographic area.
The general principles of the clause to restrain a person’s freedom to conduct business are well established. The courts have long said that a restraint of trade is contrary to public policy and the clause is void unless it can be proven that the restraint is reasonable, in the circumstances of the particular case.
However in New South Wales the position is different and it is not entirely correct to say that a restraint is void, in the first instance. The Restraints of Trade Act 1976 (NSW) approaches the position on the basis that a restraint is valid to the extent it is not contrary to public policy, even if it is not in severable terms. The effect of the Act is to allow a restraint that is too wide to be read down so as to be valid to the extent necessary. Whilst the court is empowered by the Act to read down a restraint clause it cannot redraft it.
The party contending that the clause is reasonable will need to demonstrate the restraint goes no further than is reasonably necessary to protect the legitimate business interests of the entity in whose favour the clause operates. The concept of legitimate business interests is broad and includes customer contacts, customer business practices, the employer’s pitch or pricing models, the employer’s business plan and target markets and the employer’s confidential processes and trade secrets. It is not uncommon that the former employee will argue that the restraint is unreasonable and contrary to public policy and it will be up to them to argue that defence.
The courts will look closely at what the parties negotiated and the terms of the particular clause at the time of entering the agreement. The test of reasonableness of a restraint is measured as at the time the parties entered the agreement, not at the time the restraint is sought to be enforced or is challenged, and by reference to the interests of the parties concerned and the public interest. Therefore the restraint must afford no more than the adequate protection of the legitimate business interests of the entity that has the benefit of the restraint clause.
An employer is not entitled to protection against competition. Such a restraint clause would be unreasonable and contrary to public policy. However an employer is entitled to protection against the use by the former employee of certain information or knowledge acquired by them with regard to the employer’s business affairs, in the ordinary course of trade. The relevant information or knowledge needs to be something more than mere skill and knowledge required by the employee to perform work (and become a possible competitor). The particular information or knowledge is of a kind that enables the employee to have influence over the employer’s customers, or knowledge of the employer’s confidential processes or trade secrets. This could enable them to take advantage of the employer’s business connection with its customers or the misuse of confidential information.
In most cases an employer’s customer connection is an interest which a reasonable restraint clause can protect in circumstances where the former employee was the face of the business to that customer.
The above is a general summary and not intended be legal advice.
For further information or advice contact Mark Petrucco or Megan Scott. Mark is a partner and Megan is a senior associate in the Litigation and dispute resolution team at Hall & Wilcox.