When an executive or senior manager leaves a business, they may take valuable customer relationships, confidential information, or trade knowledge with them. This can create significant risks for employers, especially when the former employee joins a competitor or starts a competing business.
Restraint of trade clauses, also known as post-employment restraints, help protect a business’s legitimate interests after an employee leaves. These clauses limit certain activities for a defined period after employment ends.
However, employers must carefully draft restraint clauses to ensure they are reasonable and legally enforceable. The information below provides a general overview of restraint of trade clauses in employment contracts. Employers should obtain legal advice based on their specific circumstances.
The Purpose of Restraint of Trade Clauses
Employers include restraint of trade clauses in employment contracts to protect important business interests. These interests may include trade secrets, confidential information, customer connections, and employee relationships.
A restraint clause will only apply if it is reasonably necessary to protect the employer’s legitimate business interests. Courts assess whether a restraint is reasonable by considering the wording of the clause and the circumstances surrounding the employment relationship.
At common law, courts generally consider restraints of trade invalid because they restrict a person’s ability to work. However, a restraint clause may become enforceable when an employer can show that the restriction goes no further than necessary to protect a legitimate interest.
Legitimate interests that employers may protect include:
- Confidential business information;
- Customer relationships and connections;
- Employee relationships; and
- Trade secrets and commercially sensitive information.
A restraint clause commonly prevents an employee from:
- Soliciting the employer’s clients;
- Starting a competing business or working for a competitor; and
- Recruiting or “poaching” employees from the business.
When Is a Restraint Clause Reasonable?
Courts consider several factors when deciding whether a restraint of trade clause is reasonable and enforceable. These factors include:
- The negotiation process: Courts may consider discussions that occurred when the parties negotiated the restraint clause.
- The bargaining position of each party: The Court may examine whether there was an imbalance of power between the employer and employee and whether the employee had the opportunity to obtain legal advice.
- The nature of the business and employee’s role: A restraint is more likely to be reasonable where an employee has close relationships with customers or access to sensitive information.
- Consideration provided: Courts may consider whether the employee received anything in exchange for agreeing to the restraint.
- The restraint period and geographical area: Longer periods and wider geographical restrictions are less likely to be considered reasonable.
Courts assess the reasonableness of a restraint at the time the employment contract is entered into. For this reason, employers should carefully consider restraint clauses when preparing employment agreements.
Employees should also seek legal advice before agreeing to restrictions that may affect their future employment opportunities.
Waterfall or Cascading Restraint Clauses
Many restraint clauses include what are known as “waterfall” or “cascading” provisions. These clauses provide several alternative restraint periods and geographical areas.
For example, a restraint clause may state that an employee cannot work for a competitor for 12 months, or alternatively, if that period is considered unreasonable, for 6 months or 3 months.
The purpose of a cascading clause is to allow a court to remove an unreasonable restriction while preserving the remaining enforceable parts of the clause.
How Do Courts Enforce Restraint of Trade Clauses?
Restraint of trade clauses are not automatically enforceable. The employer must prove that the clause protects a legitimate business interest and that the restriction is reasonable.
When determining whether a restraint clause is valid, courts generally consider two key questions:
- Does the employer have a legitimate interest that requires protection?
- Does the restraint provide reasonable protection for that interest?
If a court finds that a restraint goes beyond what is necessary, it may refuse to enforce the clause.
Legal Remedies for Breaching a Restraint Clause
If a former employee breaches a restraint clause, an employer may seek legal remedies to protect its business interests.
The most common remedy is an injunction. An injunction is a court order that prevents a person from continuing conduct that breaches their contractual obligations.
For example, an employer may seek an injunction to prevent a former employee from:
- Working for a direct competitor;
- Contacting or soliciting former clients; or
- Using confidential business information.
Tips for Businesses Drafting Restraint Clauses
Businesses should carefully review restraint clauses to improve the likelihood that they will be enforceable.
Employers should consider the following:
- Ensure the restraint period reflects the employee’s role and access to confidential information;
- Limit prohibited activities to those that genuinely threaten the business;
- Use appropriate geographical restrictions; and
- Regularly review employment contracts and update them when employee roles change.
Conclusion: Protecting Your Business with Enforceable Restraint of Trade Clauses
Restraint of trade clauses play an important role in protecting businesses from the misuse of confidential information, customer relationships, and trade knowledge after an employee leaves.
However, employers must carefully draft these clauses because courts will only enforce restrictions that protect a legitimate business interest and remain reasonable in scope.
Obtaining legal advice when preparing or reviewing employment contracts can help businesses create effective restraint of trade clauses and reduce the risk of future disputes.
This information is general in nature and does not constitute legal advice. If you or someone you know wants more information or needs help or advice, please contact us on (02) 9818 2888 or email [email protected].