In the current climate, circumstances affecting your business may be out of your control. One matter which can be critical to your business and is within your control is the protection of the goodwill and client base of your business from approach by past employees, franchisees, contractors or other commercial partners through the utilisation and enforcement of restraint of trade clauses.
Restraint of trade clauses are designed to provide protection to business owners who are looking to:
- prevent past employees from poaching clients or directly competing with their business; or
- prevent a franchisee from competing with the franchise in the event the franchise relationship comes to an end; or
- control the use by others, whether they be former directors, joint venture partners, contractors, suppliers, agents or other commercial partners, of specified information that may come into their possession legitimately while they are working in the business after their respective arrangements end.
Such clauses are ordinarily enforceable for a specified time and can commonly be found in employment, partnership, franchise, shareholders, joint venture and sale of business agreements.
If you do not ensure that appropriate restraint of trade clauses are adopted and then enforced, you are leaving your client base and the goodwill you have worked so hard to develop, susceptible to being compromised.
Wording of restraint of trade clauses
A properly drafted restraint of trade clause will give you the ability to preserve the goodwill of your business as well as to protect the relationships you have with one of your most important assets – your clients.
There are a number of issues to consider when choosing the wording of a restraint of trade clause. In particular, the use of restraint of trade clauses should be tailored to each individual circumstance to avoid the risk of it being declared unenforceable.
For example, an employee at management level who deals with clientele on a day-to-day basis would require a different restraint of trade clause to a junior employee who has limited dealings with clientele. Similarly, pro-forma restraint of trade clauses for franchisees may require differentiation for master franchisees as compared to ordinary franchisees.
The starting point is to consider what is reasonable to impose on a party in order to protect the legitimate interests of your business.
The most common and most successfully enforced restraint of trade clauses in court usually contain cascading provisions. That being, the clauses will stipulate a large geographic location for which the restraint will apply and then, as an alternative, the clause will stipulate a smaller geographical territory and then usually a third smaller geographical territory again. This decreasing set of options will be repeated also for the period of time for which the restraint may be found by the court to have effect. For example: 10 years, 5 years and finally 12 months.
If you have any concerns or queries with respect to the appropriateness of any restraint of trade clauses you use in your business please contact us to discuss your concerns.
Restraint of trade clauses are only valid and enforceable where the restraint is ‘reasonable’.
When considering whether a restraint is reasonable, the Courts take into account a number of factors including the following:
- Whether the party seeking to rely on the restraint has a genuine interest that needs protection.
- Whether the restraint is unreasonably broad and/or restricting.
- Whether the time for which the restrained party is restrained is unreasonable.
- Whether there are any other relevant factors when the agreement is read as a whole.
- The extent of activities covered by the restraint.
- Whether the area to which the restraint applies is larger than is necessary.
A recent example of a restraint of trade clause considered by the Courts when it was sought to be enforced was a case where Raine & Horne (as the franchisor) sought to rely on the following clause which, in this instance, was not cascading:
“29.1 - The franchisee and the (guarantors) agree they will not for a period of 12 months after termination (for whatever reason) of this deed, conduct or be in any way employed or interested in any real estate agency business which carries on business substantially within a 5km radius of the premises.”
The franchisee operated a Raine & Horne franchise at Brighton and Ramsgate in Sydney’s southern suburbs. Before the end of the term of the franchise agreement, the franchisee entered into a Ray White franchise agreement and ran the new business out of the same premises. Raine & Horne sought to rely on the restraint of trade clause to restrain the franchisee from operating the Ray White business.
The Court observed that the restraint could be complied with if the franchisee conducted a real estate agency business outside of the 5km radius, even if it serviced customers located within, sold or managed properties within the 5km radius, or serviced customers who had previously been customers of the business.
The Court found that Raine & Horne had interests to be protected by the restraint, including the significant goodwill it had in an existing business built up over many years, notwithstanding that goodwill had been contributed to by the franchisee.
Having come to the conclusion that the franchisor had a legitimate interest in the business of the franchisee, the Court had no trouble coming to the view that the restraint was enforceable. But practically, although the former franchisee could not operate the new franchise from the same location, it could set up a shop front outside of the 5 km radius and still service the same area. Given the uptake in the use of technology in the real estate industry, restriction on the physical location of the shopfront may not have been the strongest outcome that could have been achieved for Ray White if a different restraint of trade clause was incorporated and enforced
Use by employers
Restraint of trade clauses in your contracts of employment with your employees should be carefully worded so as to ensure they are enforceable and that they protect your interests, particularly clients from being poached by former employees.
Often, restraint of trade clauses provide that an employee will not:
- approach, canvass or solicit any clients or customers of the employer for a period;
- use or disclose confidential information after leaving employment;
- work for a competitor of the employer’s business for a period within a certain geographical area for a certain time period (eg. Within 10km of the location of the business).
The same principle of reasonableness applies to the interpretation and then willingness of the courts to enforce restraint of trade clauses in the employment context as well as other contexts.
The most common form of defence raised by former employees is an argument that the restraint is unreasonable because it prevents the former employee from earning a living, generally because the former employee has specialised skills and expertise which in unable to be translated to another field of employment and an inability to work outside whatever geographic location may have been stipulated in the restraint of trade clause.
Having effective restraint of trade clauses contained in your key agreements will provide you with the option to elect to enforce them to protect the business from actions of former business colleagues or employees. Enforcement will generally only occur after an assessment is made about the cost to the business of the actions of the former business colleague or employee and the costs of enforcement.
Failing to have an enforceable restraint of trade clause in your agreements does not leave you without legal rights but these legal rights are based on areas such as duties of confidentiality between employers and employees, breach of fiduciary duties of former partners or directors, and other areas of the law. An effective restraint of trade clause is the best mechanism to minimise risk of damage to the business, stipulate clear sanctions for breach and provide a clear means of enforcement if the business considers it commercially feasible to do so.