Protecting your hard earned business property: Restraint of Trade Clauses

How do business owners protect their hard earned confidential information, client connections, business know-how and trade secrets if an employee decides to take up employment elsewhere, particularly with a competitor?  This question arises whether you have a workforce of employees, more flexible arrangements utilising contractors or in respect to arrangements with key persons following business acquisitions.

Anecdotally, it is accepted that the work force in this day and age is much more mobile than it has ever been before.  McCrindle’s last analysis of Household, Income and Labour Dynamics in Australia survey revealed that the national average tenure in a job is 3 years and 4 months. 

McCrindle survey

One way to protect your business property is a restraint of trade clause, which usually prevents an employee from:

  • Approaching, canvassing or soliciting any clients or customers of the business for a specified period.

  • Using or disclosing confidential information after leaving the business.

  • Working themselves, or for a competitor of the business, for a specified period in a specified geographic area.

Are restraint of trade clauses enforceable?

At common law, all restraint of trade clauses are void unless they are reasonable in the interests of the parties and separately in the interests of the public. 

To be valid, restraint clauses must:

  1. Protect a legitimate interest of the business.

  2. Only be for a time period that is necessary to protect that interest.

  3. Cover a geographical area that is necessary to protect that interest.

  4. Not be too broad to prevent an employee from working.

Legitimate interest of business

The reasonableness of any restraint of trade clause will turn on whether there is a ‘legitimate interest’ of the business that requires protection.  Examples of legitimate interests include confidential information, client connections, business know-how, and trade secrets.

Time period and geographical area of restraint

Restraint clauses generally seek to restrict the employee from doing certain things for a period of time and within a certain geographical area.

When assessing the reasonableness of the time period of a restraint, the courts will do so by considering:

  • Whether the restraint allows a sufficient period for the business to re-establish its relationship with its clients through the efforts of a new employee or employees.

  • Whether the restraint allows a sufficient period to ‘sever’ the relationship built up between the departing employee and the clients of the business, so that the departing employee does not have any effective advantage by the end of the period.

Usually, the seniority of the employee and the closeness of the relationship with the clients of the business will be factors relevant to deciding a reasonable restraint period.  In this regard, it is best to be as specific as possible when defining the scope of the restraint, particularly in terms of the clients to which any prohibition on solicitation applies.

When assessing the reasonableness of the geographical area of a restraint, the identified area must not be larger than necessary to protect the business, given the circumstances of the former employee’s working arrangements with the business.  An employee who serviced the entirety of Australia for the business could in some circumstances legitimately be restrained from providing the same services in that same geographic area.  However, an employee who only ever serviced the CBD of Sydney, could legitimately argue that the geographical scope of any restraint should not exceed that area.  The actual role performed will have an impact on whether a geographical limit on a restraint can legitimately be applied.  One way of dealing with this issue is by ensuring that the scope of the restraint, as it applies to the clients or customers the subject of it, is limited and clearly articulated.

Severance and cascading provisions

In NSW, unlike other States and Territories, restraint clauses that are unreasonable may be read down pursuant to the Restraints of Trade Act 1976 (NSW). For this reason, it is common to see restraint clauses that contain cascading terms for the period of the restraint or the geographical region within which the restraint applies. 

The use of cascading provisions may allow a court to sever (or read down) those parts of the clause that are considered to be unreasonable in the circumstances.  By doing this, the balance of the restraint can be enforced.

However, there is a risk that the use of cascading provisions may allow an employee to argue that restraint clauses are not enforceable due to uncertainty. 

Concluding comments

When drafting restraint clauses, it is important that you identify:

  1. The legitimate business interests you are seeking to protect.

  2. The time period and geographical area necessary to protect your interests.

Remember, standard clauses will usually be unenforceable.  You should, where possible, tailor the restraint clause to a particular employee and periodically review the terms of the restraint (for example, when the employee is promoted into a more senior position or just to ensure the restraint remains relevant).  To ensure you can effectively enforce the restraint, make sure you have kept good records of your negotiations of the restraint with your employee, and that the employee is given an opportunity to take legal advice on the restraint before agreeing to it.

Authors: Gavin Stuart and Elias Yamine