Two recent decisions of the Supreme Court of Victoria and the Court of Appeal provide valuable insight into how Australian Courts consider the validity of restraint of trade provisions in contracts, and how the Courts distinguish between the validity of restrictive covenants in employment contracts as opposed to restraint provisions concerning employees which form part of an agreement for the sale of a business.

In the first case, Crowe Horwath (Aust) Pty Ltd v Loone [2017] VSCA 181, the Victorian Court of Appeal held that restraint of trade provisions in employment contracts are unenforceable if the contract is repudiated by the employer.

In Southern Cross Computer Systems Pty Ltd v Palmer (No 2) [2017] VSC 460, the Victorian Supreme Court upheld the validity of a four year restraint in circumstances where a key employee had sold his share in the business to the employer, and agreed to remain an employee while also agreeing to certain restraints of trade in the share sales agreement.

Restraint of trade provisions unenforceable if contract repudiated by employer

Crowe Horwath (Aust) Pty Ltd v Loone [2017] VSCA 181

Background

In November 2012, Mr Anthony Loone entered into a contract of employment with Crowe Horwath (Aust) Pty Ltd (CHA) as Managing Principal of their Launceston office (the Contract). In January 2015, CHA was acquired by Findex Group Ltd, and in June 2016, CHA advised its employees it was modifying the incentive scheme under which bonuses were paid each year. The modification meant that CHA would defer payment of 20% of the annual bonuses and distribute it over a three year period. Mr Loone contended this had the effect of repudiating the Contract, entitling him to terminate the Contract on 12 July 2016.

In July 2016, CHA applied to the Supreme Court of Victoria for an interlocutory injunction to prevent Mr Loone from providing accounting services to CHA's clients and starting his own, boutique advisory firm. CHA sought the injunction on the basis that the Contract had included a restrictive covenant that provided Mr Loone could not offer accounting services to CHA client's he'd had dealings with in the previous 12 months.

Mr Loone in his defence claimed the Contract was repudiated by CHA when it failed to comply with its contractual obligations, including paying his bonus and subsequently, the restraint clause did not survive once his employment ceased. Mr Loone contended that there was nothing within the Contract which allowed CHA to withhold a proportion of the bonus.

CHA maintained that it was the parties' intention that its post-employment restraints survive the termination of the employment in all circumstances, and for any reason.

While initially Justice McDonald made interim orders restraining Mr Loone from engaging with his former clients – His Honour later discharged the injunction, concluding that the covenants did not survive the termination of the Contract "effected by Mr Loone's acceptance of CHA's repudiatory conduct". CHA appealed the decision however the Court of Appeal upheld Justice McDonald's decision and dismissed the appeal.

In reaching its decision, the Court of Appeal considered a number of authorities and ultimately decided, inter alia, that:

"A series of decisions in the High Court, and in courts of high authority in England and Canada, have stated, over the course of more than a century, that a restraint clause is not enforceable against an employee whose employment ends by the employer’s wrongful conduct — whether it be wrongful dismissal or the employee’s acceptance of the employer’s repudiatory conduct. Sometimes, that affirmation has been the ratio of the decision. In other instances, it has been by way of obiter dictum.

So far as the researches of counsel, the trial judge and this Court have revealed the situation, there is no reported case in a court of superior jurisdiction in Australia or England which has decided that a restraint clause is enforceable against a former employee in such circumstances."

Four year restraint upheld

In the subsequent case of Southern Cross Computer Systems Pty Ltd v Palmer (No 2) [2017] VSC 460, Justice McDonald upheld a restraint period of four years.

Mr Christopher Palmer sold his 40% shareholding in Southern Cross Computer pursuant to a share sale agreement. The agreement also provided that Mr Palmer would remain as an employee of Southern Cross Computers and would be subject to a number of restraints which operated for a period of up to four years following the completion of the sale agreement.

However, following the sale, Mr Palmer began providing services one day per week to a direct competitor of Southern Cross Computers - Blue Connections Pty Ltd.

Justice McDonald summarised the "well settled" principles governing the enforceability of restraint clauses, and ultimately found that the four year restraint was reasonable because:

  1. Mr Palmer was designated as a key employee in the share sale agreement;
  2. The four year restraint period was a term of the share sale agreement and was freely entered into by Mr Palmer's company;
  3. Southern Cross Computers paid a substantial amount of consideration in return for the terms of the agreement; including the restraints imposed on Mr Palmer; and
  4. The share sale agreement provided that Mr Palmer would continue as an employee.

In reaching his decision, Justice McDonald noted that, "there is nothing exceptional in a four year restraint in the context of a goodwill case where the vendor receives a substantial amount of consideration".

Take home thoughts

Employers should be mindful that any substantial change in an employee's terms and conditions of employment could amount to a repudiation of the employment contract, which if accepted by the employee, will impact on the employer's ability to later rely upon restraint of trade clauses in the contract of employment.

When considering the enforceability of restraint clauses generally, a stricter view is taken of covenants in employment contracts than those in share sale agreements, and the Courts are likely to uphold the validity of longer than usual restraint periods in the context of a goodwill case where the vendor receives a substantial amount of consideration, if the restriction is reasonable by reference to interests of the parties.