Much damage can be done to a business when an executive or senior manager resigns, taking with them valuable customer and confidential information. Restraint of trade clauses, or post-employment restraints, play a crucial role in protecting the legitimate interests of the employer.
In order to protect business interests employment contracts should contain protections which operate after the employment ends.
The purpose of Restraint of Trade Clauses
Restraints of trade are included in employment contracts to protect an employer’s trade secrets, confidential information, customer connections and staff connections by restricting an employee’s activities after they have left employment.
A restraint clause is void unless it is reasonably necessary to protect the legitimate interests of the employer. The legitimate interests of a business will generally relate to confidential information, trade secrets and customer connections.
Accordingly, a restraint clause in an employment contract will only be enforceable if the restrictions imposed are no more than necessary for the protection of the employer’s legitimate business interests – this will depend on the particular clause and the circumstances of each case.
A restraint clause typically prevents an employee from:
- contacting the employer’s clients for the purposes of selling goods or services or enticing the clients away from the employer;
- setting up a business competing with the employer’s business or working in a competitive business; and
- poaching employees of the business.
When determining whether restraint clauses are reasonable, courts will consider the following:
- The negotiation process, and in particular comments made when negotiating restraint clauses.
- The bargaining position of the parties. Was there an imbalance of power between the employer and the employee at the time of agreeing to the restraint? Did the employee have the opportunity to obtain legal advice?
- The nature of the employer’s business and characteristics of the employee. The closer the employee is to the employer’s customers, the more likely the restraint may be considered reasonable.
- Whether any consideration was given for the restraint.
- The duration and geographical area of the restraint. The longer the time and wider the area, the less likely it will be reasonable.
The reasonableness of the restraint must be decided at the date of entering into the employment contract. For this reason, it is important that the parties to the contract each have an opportunity to negotiate the terms of a restraint. In addition, employees should be encouraged to seek legal advice about the length and the effect of the restraint.
The trend of Waterfall or Cascading Clauses
Restraints are often applied for a specified period, in relation to a particular geographic area.
A common device for reducing the risk of invalidity on the ground of unreasonableness is to include ‘waterfall’ or ‘cascading’ clauses. These are alternate provisions contained in an employment agreement that may enable a court to strike out a harsher (unreasonable) restraint whilst retaining a less-restrictive and reasonable clause.
The advantage to these is that each clause is severable by a court without affecting the validity and enforceability of the restraint.
How do courts enforce restraint of trade clauses?
Employment contracts and restraint of trade clauses must be carefully drafted to ensure they can be enforced through a court. In such cases, an employer must persuade the court that the clause is reasonable and therefore valid and enforceable.
When considering enforceability, the court will consider two key issues:
- whether the employer has a legitimate interest to protect; and
- whether the restraint is a reasonable protection of that interest
What are the legal remedies?
The common remedy sought by employers faced with an employee’s breach of a restraint clause is to seek an injunction to restrain an employee or former employee from acting in a way, or continuing to act in a way, that breaches a term of the former employment contract. For example, an injunction may prevent a former employee from working for a competitor for a certain period of time or from using or disclosing information confidential to the former employer and its business.
Some Tips for business owners
Some tips for drafting restraint clauses in employment contracts:
- Make sure the period of restraint is appropriate to the employee’s position and access to confidential information.
- Make sure the prohibited activities to be prevented are similar to the employee’s current activities.
- Ensure contracts are reviewed regularly and updated to reflect changes in the employee’s role.
Having an enforceable and valid restraint in employment contracts is crucial if an employer hopes to rely on it to enforce a former employee’s post-employment obligations.
This issue needs to be considered by employers when the employment contract is drafted because a court will consider the reasonableness of the restraint as at the time the contract was entered into. The courts will only find that a restraint clause is valid and enforceable where a business can demonstrate that it has a legitimate interest to protect and that the clause is reasonable.
We are able to review, draft and advise on restraint clauses and their enforceability generally. If your business needs assistance, please contact us on (02) 9963 9800 or via our contact form here.