Restraint clauses are not ‘one size fits all’. Typically, courts look less favourably on restraints imposed on an employee than restraints imposed on a vendor to protect the goodwill of a business in a sale. So to be enforceable, restraints need to be considered and drafted appropriately for the circumstances for which they are being used.
In Australia, restricting a person’s freedom to work for a competitor is generally contrary to public policy. A provision in an agreement (be it in an employment or sale of business context) that purports to restrain a person in this way will generally be void, unless the restriction is reasonable having regard to the interests of the parties and the interests of the broader public.
A non-compete is unreasonable and unenforceable if it extends beyond what is necessary to protect the person for whose benefit the restraint is being imposed. Determining what is necessary is driven by the facts of a matter and, accordingly, the enforceability of a restraint clause is determined on a case by case basis.
In the context of a business sale it can be acceptable to impose a restraint for several years post the sale date, but courts will generally take a less favourable view of lengthy restraints placed on employees. While there is little difference in the structure and form of a restraint clause in each context, what is considered reasonable in the sale of a business context will not necessarily be considered reasonable in an employment context.
Where the goodwill of a business has been sold, a court is generally more focused on commercial fairness and the need to hold the parties to the bargain that they have struck. In an employment context, the courts recognise that there is an inequality of bargaining power and that the individual concerned will often have no other way to make a living.
Restraints of trade in business sale agreements
A buyer will typically insist that the sale documents in an acquisition incorporate a restraint of trade restricting the seller’s ability to compete for a minimum period post the sale date. This is primarily to protect the buyer from competition that may prejudice the value of the goodwill in the target.
Courts have generally upheld clauses that restrain a seller’s post-completion conduct on the basis that the buyer is entitled to reasonable protection of the goodwill that they have purchased, particularly where valuable consideration has been paid for it. Compared to restraints imposed on employees, the restraint in a business sale context can be lengthy.
In Southern Cross Computer Systems Pty Ltd v Palmer (No 2), Mr Palmer was restrained from engaging in a competing business providing IT procurement and management services in Australia for four years after selling his 40% shareholding in Ingenio Group Pty Ltd to Southern Cross Computers Pty Ltd (Southern Cross).
Mr Palmer was subsequently contracted by a competitor, but the Supreme Court of Victoria ultimately found that the restraint provision in the share sale agreement was valid and enforceable. The Court took into consideration the fact that Mr Palmer had freely entered into the share sale agreement and had received $3.5 million as consideration. The Court noted that the restraint was suitably limited to protect the business as it was being carried out at the date of the sale and was reasonable in its geographic reach and the period of operation.
Before enforcing a restraint, a court will need to be satisfied that the scope of the restraint is reasonable. In Freedom Finance Accounting Pty Ltd v Goldstein, Freedom Finance Accounting Pty Ltd (Freedom) entered into a share sale agreement to purchase Mr Goldstein’s 50% shareholding in an accounting firm for $358,500. Mr Goldstein was restrained from providing accounting services and non-accounting services for a period of three years. After his resignation, Mr Goldstein commenced work with a suburban accounting firm, requiring Freedom to seek an order enforcing the restraints against Mr Goldstein.
The Court held that the restraint on Mr Goldstein was too wide. The restraint extended to services of a kind that Mr Goldstein never provided to his clients and had no reference to the goodwill acquired by Freedom. Further, the non-compete area and the period of operation extended beyond what was necessary for Freedom to consolidate the business and take advantage of the goodwill that it had purchased.
Restraints of trade in employment contracts
For a restraint imposed by an employer to be enforceable, it must be directed at protecting an employer’s legitimate proprietary interest (such as its confidential information, customer connections or a stable workforce).
In Thinkstorm Pty Ltd v Farah, Mr Farah, a specialist in WorkBrain software, was employed by Thinkstorm Pty Ltd (Thinkstorm), a recruitment agency, and assigned to work for one of Thinkstorm’s clients, Queensland Health.
Mr Farah later resigned from Thinkstorm and commenced employment with a competing recruitment agency, Paxus Australia Pty Ltd (Paxus). He was then reassigned to Queensland Health through Paxus. Following this, Thinkstorm sought to enforce a restraint in its employment contract with Mr Farah to prevent him from providing WorkBrain services to Queensland Health for a period of 12 months.
When considering the validity of the restraint, the New South Wales Supreme Court acknowledged that Thinkstorm had built a relationship with Queensland Health, independent of Mr Farah. This relationship manifested itself in business goodwill, which was a legitimate protectable interest. The Court held that the restraint was reasonable in scope to protect that interest. The restraint did not prevent Mr Farrah from providing his professional services to other parties and the 12-month period of operation, while at the “outer limit”, was considered reasonable in the circumstances.
The courts recognise the broader public interest in ensuring individuals can work and compete freely and adopt a strict approach towards restraints imposed in the employment context. Notwithstanding this general position, as this case demonstrates, a restraint that is reasonable and directed towards protecting a legitimate interest may be enforceable.
Where an employee will continue to be paid during the period of a restraint, the court may consider a longer restraint period to be reasonable.
- In a business sale agreement, a restraint should be aimed at protecting the business as it was being carried out at the time of completion.
- In an employment contract, a restraint must be directed at protecting the employer’s proprietary interest. The “reasonableness” of the restraint is considered as at the time the contract was entered – not when the employment came to an end.
- Once a protectable interest is established, the restraint should be crafted in such a way as to protect that interest. The restraint must be reasonable in extent, duration and geographic reach.
- Whether a restraint is enforceable will be determined on a case by case basis. For this reason, we usually recommend clients consider using a cascade clause to assist in ensuring “reasonableness” when defining the period of operation and geographic reach.
- In the context of a sale of business where vendors or associates of vendors will be employed in the target’s business on a continuing basis, a buyer should ensure that separate restraints are negotiated that have regard to the different contexts in which they are being sought.