May 2003

Restraint of Trade - are you protecting your interests?

As an employer, you have been using for some time a standard restraint of trade clause in your contract of employment with your employees. The restraint of trade clause is more of a deterrent than a clause you ever want to rely on.

Then the unexpected occurs. An employee resigns and commences working for a competitor. The employee starts approaching your clients and customers. You suspect they are misusing confidential information that they obtained during their employment. You want to enforce the restraint of trade clause to protect your business. You now ask, is my restraint clause effective?

A restraint clause

A restraint clause seeks to impose limitations or restrictions on an employee's conduct after they leave employment. Often restraint clauses provide that an employee will not:

  • Approach, canvass or solicit any clients or customers of the employer for a period of X months, or

  • Use or disclose confidential information after leaving employment, or

  • Work for a competitor of the employer's business for a period of X months in Sydney.

These clauses are intended to protect an employers legitimate business interests - its confidential information and clients.

The Principles

Restraint clauses are only valid and effective if they are reasonable, or can be read down so as to be reasonable under the NSW Restraints of Trade Act 1976.

What is reasonable will depend upon the subject matter of the restraint, the time and area of its operation, the nature of the employer's business and the industry in which the employer operates, the relationship of the employee to the employer's clients and customers, and the nature of the work performed by the employee.

A court in considering whether a restraint is reasonable and valid is often asked to decide between two competing interests, an employee's freedom to earn a living against the need of an employer to protect its legitimate business interest. An employer cannot protect itself against mere competition.

Confidential information

As part of an employee's obligation of good faith, the employee must not disclose or misuse confidential information obtained during their employment. This obligation exists regardless of whether it is contained in a restraint clause.

The courts will only protect the misuse of information where that information is truly confidential. To establish that a party has misused confidential information in breach of their duty of good faith, an employer must show that the information has the "necessary quality of confidence about it", the information is imparted in circumstances importing an obligation of confidence and that the employee has misused the information to the harm or loss of the employer.

Where employees have deliberately copied customer lists or business records before leaving employment and did so to use them to compete against their employer, the courts have restrained the employee and awarded damages for the employer.

Some matters to consider with restraint clauses

Dealing with restraint clauses is complex and difficult. However, it is possible to identify some principles and issues that can guide parties to determine whether a restraint clause will be effective.

Let's examine the clauses illustrated above and identify some of these principles and issues.

"Approach, canvass or solicit any clients or customers"

Referring to any client or customer in a restraint is potentially too wide. An employee who does not deal with clients or customers, or who even indirectly deals with clients or customers through a manager could not ordinarily be restrained from approaching these clients after leaving employment. However an employee who deals directly with an employer's clients and customers could be restrained.

"Use or disclose confidential information"

As we noted above, an employer can prevent an employee from using or disclosing truly confidential information. But when a restraint clause defines confidential information to include "any information obtained in the course of employment" or information that is not by its nature confidential, the restraint will be too wide. You cannot prevent an employee from using their know-how or information the does not have that character of confidence.

"Period of X months"

It is common for restraint clause to restrict an employee for working for a period of time. What is an appropriate length of time can often be determined by asking: what is the time for a reasonably competent new employee to master the job and demonstrate to customers that he or she is effective and efficient? If X months is longer than the time it takes a new person to master the job then the restraint is probably unreasonable and ineffective.

"In Sydney"

It is also common for restraints to restrict an employee from working within a certain geographical location. In the example, is Sydney area too wide a restraint to prevent competition from an ex-employee? Take for example a doctor in a local surgery at Cronulla. A restraint preventing the doctor from establishing a local surgery in Penrith would be unreasonable and ineffective.

An effective restraint clause

To ensure any restraint clause will be effective employers should:

  • Avoid using standard or pro-forma restraint clauses;

  • Tailor the restraint to the employee's individual circumstances;

  • Consider the interests that are to be protected by the restraint and ensure that those interests are legitimate;

  • Ensure that the time and geographical area for which the employee is to be restrained is not more than necessary to protect your business but not to restrict competition; and

  • Review any restraint clause when you review an employee's contract of employment.

Conclusion

A properly drafted restraint of trade clause for an employee is an effective tool to protect an employer's legitimate interests from competition by an ex-employee. A properly drafted restraint clause is capable of enforcement where as a poorly drafted or inappropriate restraint clause will leave an employer with little comfort.