We all have those 3am panics about the business decisions we make (it’s not just me, right?). One of the hardest decisions we make is when we bring in others to work with us.
Planning for the departure of a key employee is as critical as their onboarding. Enter the legal concept of ‘restraints of trade’, designed to protect your business from potential future damage that an employee can cause on their way out.
You may have heard that restraints of trade are not worth the paper they’re written on. You can be pretty sure we wouldn’t be writing this blog if that were true. So what can you include?
This blog post covers the different types of restraint and their enforceability. It is not legal advice and you are encouraged to engage a lawyer experienced in this area if you want to properly protect your business.
What types of restraint are there?
There are many different types of restraint we can consider as part of your arsenal to protect your business against being replicated or damaged by employees who learn from you whilst they sit inside your business.
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- Non-solicitation: These can be used to prevent ex-employees from poaching clients or fellow employees, ensuring your workforce and client base remain intact. It can also extend to contractors, suppliers and other people who are critical to your business.
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- Non-compete: These can be used to prevent ex-employees from opening a business similar to yours within a certain time period of the end of their employment. These can also be used to restrict side hustles particularly in competing businesses whilst they are employed by you.
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- Confidentiality: All employees owe an implied duty of confidence meaning that they can’t use your confidential information to your detriment. Most employment contracts will also include a confidentiality clause to make this abundantly clear.
Looking beyond your employees, you can also attack this at another level. Exclusive dealing agreements might be used with contractors, suppliers and other people who are critical to your business to make sure they can’t deal with your competitors, ex-employee or otherwise. Exclusive dealing (when done right) can prevent competitors from accessing the same resources and may even increase the value and goodwill of your business.
So why are they controversial?
Restraints are often criticised for not being reasonable. Whilst it may be reasonable to prevent a top sales executive jumping ship to your main competitor the next day, taking your trade secrets and client relationships with them, it may not be reasonable to prevent a doctor from being able to work as a doctor in the same town and requiring them to move away if they want to keep doing what they are trained to do.
The balance between protecting trade secrets and goodwill versus allowing employees to make money out of what they are trained to do, is a delicate one.
Fairness is scrutinised by the court to make sure that restraints go no further than what is absolutely necessary to protect legitimate business interests. The type of industry, seniority of employee, potential for damage, length of time and distance of the restraint are all considered carefully for fairness.
How do they work in practice?
Mr O’Shea was a business development manager at Emeco International and described as the ‘face of the company’ to Emeco’s customers and potential customers. He built close relationships with important clients in a very competitive industry. He had access to confidential information which could be damaging to Emeco in the hands of a competitor.
Mr O’Shea resigned just short of two years into his employment and immediately went to work for a competitor. Emeco took him to court to get an urgent injunction to stop him from working for the competitors. The court granted this application and Mr O’Shea was stopped from working until a trial could occur, which the court listed to occur within four weeks.
Emeco relied on a:
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- 6 month non-solicitation of clients;
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- 6 month non compete to stop him working for competitors; and
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- Confidentiality clause in the employment contract
The court quoted a High Court decision which said:
Where an employee is in a position which brings him into close and personal contact with the customers of a business in such a way that he may establish personal relations with them of such a character that if he leaves his employment he may be able to take away from his former employer some of his customers and thereby substantially affect the proprietary interest of that employer in the goodwill of his business, a covenant preventing him from accepting employment in a position in which he would be able to use to his own advantage and to the disadvantage of his former employer the knowledge of and intimacy with the customers which he obtained in the course of his employment should, in the absence of some other element which makes it invalid, be held to be valid.
The court looked at Mr O’Shea’s job description, the clients he had access to, the special relationship he had with the clients, and the strategic information he had access to. They also looked at how competitive the industry was.
The court agreed with the non-compete. However, they were not so happy with the non-solicitation of clients as it applied to all clients of Emeco, not just the ones that Mr O’Shea dealt with. The court said that they “go further than is reasonable to protect the legitimate interests of Emeco.”
What is a waterfall clause?
Understanding that courts look so closely at fairness of length of time and distance, a bizarre practice emerged which I regularly need to explain to clients because it doesn’t really make logical sense. They are called waterfall clauses.
An example is as follows:
The Restraint Period is the period of employment and for the following time periods after the end of the employment:
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- 2 years;
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- 18 months;
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- 12 months;
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- 9 months; and/or
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- 6 months.
I have had many clients point this out to me throughout the years as it looks like the contract wasn’t properly finished. And that is a fair criticism! Waterfall clauses are an attempt to guard against the courts saying that the clause is unfair.
Courts are not able to rewrite a contract to make it fair, but can cross out things that are unfair and leave the parts that are fair. So once a clause has gone through court where it has been decided for example that two years is unfair and it is crossed out, there is still a backup position of 18 months. And if 18 months were also considered unfair, then the restraint may be upheld for 12 months and so on until they reach an option that is considered fair (if any).
The Restraint Period is the period of employment and for the following time periods after the end of the employment:
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2 years;
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18 months;
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- 12 months;
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- 9 months; and/or
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- 6 months.
These are tricky. Bear in mind that vague clauses can lead to disputes and unenforceability. Clear, precise language is essential.
Is the law likely to change?
Cases that come before the courts often change our understanding of an area of law. Although the principles of this area of law is fairly well settled, it is currently being reviewed by the Australian Government. They are exploring a “potential prohibition on post-termination worker restraints of trade, no-poach and wage fixing agreements.”
The Issues Paper references studies indicating that non-compete clauses hinder job mobility and innovation, have a “chilling effect” on entrepreneurship, and shrink the pool of available workers, posing significant challenges in industries facing labour shortages.
Additionally, the paper highlights that non-competes lead to slower wage growth and diminish workers’ bargaining power while employed. It also expresses concerns that non-competes might discourage employees from leaving their current positions, impeding the entry of new businesses and the expansion of existing ones. The paper explains that to comply with non-compete clauses, workers may shift to different industries, leading to an inefficient allocation of their skills and training.
Finally, the paper raises whether non-competes mean that clients may not be able to continue a productive relationship with a worker with whom they have built a connection.
The review will also need to take into account that businesses who can’t be sure that their employees will actively work against them, may not invest in employees and this can also impact economic growth.
Reforming what is considered the right balance between all of these interests is certainly an interesting area and one to watch.
Submissions closed on 31 May 2024 and we can expect an announcement to be made in the medium term. It is unclear what impact an election next year might have on how this proceeds.
Final thoughts
One of the most heartbreaking parts of my work is dealing with business owners who feel betrayed by senior employees who seek to funnel off part of the reputation or goodwill of a business they used to work for, for their own advantage at the expense of their ex-employer.
Having options can provide some comfort to business owners wishing to protect their businesses.
Restraints of trade need to be carefully crafted to be considered fair and enforceable. There is no one-size-fits-all.
A tech company might focus on protecting intellectual property, while a sales firm might prioritise protecting client relationships. But well-drafted restraints can provide peace of mind, ensuring that when the 3am panics strike, or an employee resigns, you know you have what you need to make sure your business is protected.
If it’s time your employment contracts were reviewed by someone who reads these cases for fun (cue Curium Legal), send them through to us for a no-obligation quote.
Reach out via a free curiosity call or:
> Phone: 0492 945 068
> Email: sarah@curiumlegal.com.au
