In the recent decision of Southern Cross Computer Systems Pty Ltd v Palmer (No 2)  VSC 460, the Victorian Supreme Court stopped an IT specialist (the employee) from working for a competitor after it found a four year restraint period imposed on the employee to be reasonable. To sell his 40% shareholding in the company – Southern Cross Computer Systems (Southern Cross) – the employee had entered into a sale agreement which included the restraint clause in question. After some dispute as to the interpretation and scope of the restraint clause, McDonald J found that it afforded no more than reasonable protection of the purchaser’s goodwill in the business attributable to the shareholding. This article will examine how the Court construed the clause in the context of the sale agreement and how the four year restraint period was found to be reasonable.
Mr Palmer, the employee, worked as an IT specialist at Southern Cross and also owned 40% of the shares in the IT provider through a company he controlled, Lendossa. He had been an employee of Southern Cross since 2001, when on 28 June 2016, he sold his stake in the company to Ingenio Group pursuant to a Share Sale and Purchase Agreement (the Agreement). The Agreement provided for Mr Palmer to remain an employee of Southern Cross, while imposing a number of restraints on him for a period of up to four years until 28 June 2020. The Agreement provided for payment of $3.5m to a trust controlled by Mr Palmer.
Meanwhile, Mr Palmer had been working one day per week for a competitor, Blue Connections, for several months before he entered into the Agreement, receiving $5000 a month for his services. On 27 June 2017, Southern Cross and Ingenio sought an interlocutory injunction restraining Mr Palmer from working for Blue Connections, which the Court granted. On 27 July 2017, the plaintiffs sought orders extending that restraint to the four year period provided in the Agreement.
The restraint clause
Clause 14.1(a) of the Agreement contained the restraint clause in issue. It provided:
During the Restraint Period, each Restricted Person must not, within the Restricted Area directly or indirectly, either on their own account or as an employee, member, shareholder, unitholder, director, consultant, adviser, contractor, principal, agent, manager, beneficiary, partner, associate, trustee, nominee, custodian, financier, representative, salesperson or in any other capacity whatsoever for any other person, firm, association or corporation (except as is expressly permitted by this agreement):
(a) Carry on, engage in or have any involvement in the Restricted Business.
The restraint clause was to be read in conjunction with the definition of Restricted Business and Business in the Agreement. Restricted Business was defined as ‘any business which is competitive with, or likely to be competitive with, the Business at the relevant time during the Restraint Period.’ Business was defined as ‘the business of IT procurement and associated IT managed services carried on by the Company.’
The question before McDonald J was whether the restraint clause, read together with the above definitions, imposed a restraint which operated beyond the scope of the business of Southern Cross as at 28 June 2016. In such a case, the restraint would likely be unreasonable and therefore unenforceable.
The plaintiffs’ case was that the clause, read together with the definition of Business, confined the scope of the restraint to the activities carried on by Southern Cross as at 28 June 2016. On the other hand, the defendants submitted that the definition of Restricted Business extended the scope of the business protected from competition by the restraint beyond that which existed when the Agreement was entered into. This created, it was submitted, an ‘ambulatory effect’ shielding the business activities of Southern Cross for the four year period if the scope of those activities were to broaden after 28 June 2016.
Justice McDonald referred to the well settled principles governing restraint of trade clauses, making particular note of the greater tolerance of such clauses in contracts for the sale of a business as opposed to when they are used in employment contracts. The Court relevantly quoted Judd J in Allison v BDO (NSW – Vic) Pty Ltd:
There can be no doubt that the purchaser of goodwill is entitled to reasonable protection of the goodwill. That is a matter which will be prominent in the mind of a court in deciding whether or not a restraint is enforceable.
The test focuses on what is reasonably necessary to protect the goodwill in the business which has been sold.
The Court considered there to be three matters bearing on the reasonableness of the restraint.
- The first question was the degree to which the restraint extended beyond the scope of Southern Cross’ business as at 28 June 2016 – the key point of contention between the parties.Justice McDonald ruled that the phrase ‘at the relevant time during the Restraint Period’ in the definition of Restricted Business did not extend the operation of clause 14.1(a) beyond the scope of the business activities undertaken by Southern Cross as at 28 June 2016. This would be so whether or not the activities to which the aforementioned phrase applied were those of Southern Cross – as contended by the defendants – or those of a competitor; a distinction on which the defendants relied. To demonstrate, the Court noted that if Southern Cross were to expand its business activities after 28 June 2016 – for instance, into manufacturing computers – those new activities would not be caught by the definition of Restricted Business because it would not come within the definition of Business. Further, the Court ruled that an amendment to a draft of the Agreement did not expand the scope of the restraint, nor constitute objective evidence that the parties mutually intended the restraint to apply more broadly than concluded above.
- Secondly, the Court considered the geographic reach of the restraint, provided in the cascading definition of Restraint Area.While the purported Australia-wide reach of the restraint might have been objectionable, the definition of Restraint Area was to be read together with the definition of Business. This had the effect of limiting the scope of the geographic constraint to areas where a business is competing with the IT procurement and associated IT managed services carried out by Southern Cross.
- Thirdly and finally, the Court considered the four year duration of the restraint which was the maximum period prescribed by the definition of Restraint Period.Justice McDonald found the four year restraint period to be reasonable, on the basis of several factors, including; the length of time Mr Palmer had worked at Southern Cross and his designation in the Agreement as a ‘Key Employee’; the substantial amount of consideration paid in return for the acceptance of the restraint; that Mr Palmer’s company freely entered the Agreement; and that Mr Palmer had signed a one year employment contract with Southern Cross such that the restraint would not in practice operate until June 2017.
Concluding, McDonald J noted that there was nothing exceptional about a four year restraint in the context of a goodwill case where the vendor receives a substantial amount of consideration, referring to other cases in which restraints of longer duration had been enforced by courts.
Lessons for Employers
- Restraint clauses are increasingly being litigated and enforced by courts which demonstrates that they are an effective way to protect your business. However, it is important that you ensure that the restraint clauses are well drafted, as the most common challenge to a restraint is that the drafting is unclear and uncertain and therefore the restraint is unenforceable.
- Courts will more readily enforce a restraint clause in favour of a purchaser who has paid a significant amount for the goodwill in a business. Although a restraint clause in favour of an employer may also be enforceable as against an employee outside of the sale context, if an employee has sold a substantial shareholding in the business, then the restraint is more likely to be seen as reasonable.