Post-employment restraints, also known as ‘restraints of trade’, refer to clauses contained within an employment agreement that seek to prevent former employees from engaging in a range of competitive activities after their employment ends.
Restraints of trade can be contained in various types of agreements, including: employment agreements, business sale agreements and/or shareholder agreements. For the purpose of this article, we have focussed on restraints of trade in the post-employment context.
Litigation regarding the enforceability of a restraint of trade is common. The most common types of restraints of trade are:
Historically, Courts have often construed restraints narrowly. The general principle is that restraint clauses are prima facie (on first impression) unenforceable. However, an employer may be able to enforce a post-employment restraint against a former employee if they can show that the restraint is reasonable to protect the legitimate business interests of the employer. Quite often the claims of breach of restraint clauses are tied in with allegations of misuse of confidential information.
The two key competing interests that must be weighed up by a court are:
Below are some recent cases that highlight the way in which restraints of trade operate and some important lessons that flow from the way that these cases were managed.
This matter involved an application by King Kong Corporation Pty Ltd for orders against a former employee.
This matter was heard on an ex parte basis, meaning that the former employee was not present during the interlocutory hearing.
At the hearing, King Kong was granted an interim injunction restraining the former employee form using, copying or distributing in any way documents containing confidential information and intellectual property of King Kong, which the former employee had downloaded prior to the termination of their employment.
In deciding to order the interim injunction, Justice Wheelahan reasoned that damages would not be an ‘adequate remedy’ in instances where the employee used the confidential information and breached their contract.
At the subsequent hearing, the former employee entered into undertakings including:
This case highlights the importance of employers being decisive in taking swift action to protect their rights.
By applying pressure and having the matter heard on an ex parte basis, King Kong was able to bring the matter to a conclusion promptly with a favourable outcome.
In these joint cases, two employees (a manager, McMurchy, and business sales partner, Kumaran) moved from Employsure to Elmo, a competing company that sold a similar software product. Both employees had restraint clauses that prevented them from working for a competing company for 12 months.
At first instance, the NSW Supreme Court upheld the restraints for both employees but ‘read down’ the restraint period to nine months, which it considered reasonable.
In McMurchy’s case on appeal, the NSW Court of Appeal upheld the nine-month restraint period. The Court reasoned that McMurchy was at risk of affecting his ability to perform his duties to Employsure during his restraint period if he worked for a competitor as a manager responsible for a team that sold a competing product. McMurchy was on gardening leave when he moved to Elmo, and was still obliged to be available to respond to issues and perform duties as requested.
Given McMurchy’s seniority and knowledge in the company, Employsure had a ‘legitimate protectable interest’ in its ‘highly confidential’ materials.
In Kumaran’s case on appeal, however, the Court of Appeal found that a nine-month restraint period was unreasonable. This was mainly due to Kumaran’s low-level position in the company.
Justice Gleeson noted that Kumaran’s low seniority meant that it was unlikely that any confidential information he did receive would be relevant for the entire nine-month period. The Court believed that this low level positioning meant ‘much of what he may have been exposed to will have evaporated from his head’.
Evaporation aside, the differing decisions in these connected cases show that an employee’s seniority (and therefore their level of access to confidential materials and intellectual property) can affect the level of risk to their previous employer’s business. Greater seniority (and hence greater level of access to confidential information and intellectual property) may be relevant in justifying a longer restraint period.
To increase the likelihood of a restraint being enforceable, it is essential that the clause itself is well drafted and that proactive steps are taken when an employee gives notice of their resignation or when their employment is being terminated.
In determining the enforceability of restraint clause, the courts will usually have regard to:
Therefore, when drafting a restraint clause in an employment contract, it is important to tailor the clause to the specific employee. Employers should turn their mind to what is reasonable in the circumstances given the employee’s role within the organisation and the types of information and clients to which they may have access.
We strongly recommend that employers seek legal advice in the restraint drafting process. This also includes seeking legal advice when updating restraints as employees are promoted. It is all too common that a clause that was originally drafted by a lawyer has been rendered ineffective through later amendments made without consulting a lawyer.
As outlined above in the case of King Kong, being proactive is essential to managing the end of an employee’s employment. If the employee is subject to a restraint in their employment contract, employers should remind them of their post-employment obligations as part of the off-boarding process and be clear as to the extent
of the restraint.
The Workplace Advisory and Disputes team at Gadens have prepared a comprehensive employee off-boarding checklist. Please contact a member of our team for further information.
When hiring new employees, employers should be aware that they may be subject to a restraint from their previous employment. Therefore, it is essential to clarify this during the interviewing and on-boarding process. If there are concerns that the employee may be subject to a restraint which prevents them from working with you, legal advice should be sought.
The Workplace Advisory and Disputes team at Gadens regularly provides advice about employment contracts and post-employment restraints and is able to assist you with any queries.
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George Haros, Partner
Diana Diaz, Special Counsel
Grant Klemm, Associate
Carlyna Yap, Lawyer
Leo Rodrigo, Lawyer