Published 22 March 2017
Protecting the interests of a business, including confidential proprietary information and customer relationships, is increasingly challenging for business owners. The law offers only limited protection of confidential information and in the modern context, in which information is more vulnerable than it has ever been, it is important to ensure that your employees are subject to an enforceable contractual obligation. There is also nothing at common law or statute to prevent a former employee from poaching your customers or clients. Post-termination restraint clauses have therefore become essential for many employers to protect their valuable and hard-earned proprietary interests.
Are Restraints Enforceable?
A common misconception is that post employment restraints cannot be enforced. This is not true. The common law provides that a covenant in restraint of trade will be presumed to be unenforceable, however a clause will be enforceable if the employer can prove that it is reasonable, and no more than is reasonable, to protect a legitimate business interest. The classes of ‘interest’ that are regarded as protectable are generally limited to confidential information, customer connection, and in some cases employee cohesion or ‘team glue’.
These interests have led to four primary types of clause. ‘Non-solicitation’ clauses prevent employees from soliciting, or accepting, work from a client of the employer; ‘non-disclosure’ clauses prevent employees from disclosing specified information, and ‘non-poaching’ clauses prevent the solicitation of former colleagues. In some instances, ‘non-compete’ clauses can also be used, which prevent an employee from directly competing with the former company. However, a non-compete will only be held to be reasonable if it the employee’s engagement in the competitive activity will inevitably lead to a breach of confidential information or loss of customer connection. If a non-solicitation or non-disclosure clause is regarded as sufficient for the protection of the employer’s interests, then a non-compete is not likely to be regarded as reasonable. Avoiding legitimate competition from someone that you have employed, with nothing more, is not a protectable interest.
Some Key Considerations when Drafting Restraints
An employer’s ability to enforce non-disclosure and non-compete covenants will often depend upon the nature of the confidential information in question. It is essential that the contractual document defines the confidential information that the employer seeks to protect with an appropriate level of detail. Often this will need to be done specifically for each class of employee. Many employers attempt to define confidential information in very broad ‘catch-all’ terms across an organisation, only to find that such clauses are unenforceable as they have not properly tied the definition to the legitimate business interests the employer seeks to protect. Alternatively, it is another common mistake for employers to be specific about what is being covered, but include information which does not genuinely have the requisite character of confidentiality. This can also cause a restraint to fail.
Contract Formation Date
The ‘reasonableness’ of a restraint is assessed by a court at the time the contract was made, not at the time that it was breached. Therefore, what experience or seniority that was gained during the employment and what work was ultimately performed by an employee is not relevant to whether a restraint provision is enforceable. Whether a restraint will be enforceable depends upon what was in the minds of the parties when the contract was signed. Was it envisaged that the employee would have a client facing role? Was it contemplated that they would be significantly promoted? Was it known that they would become the face of the business? If the answer to any of these is negative, then a restraint seeking to prohibit the solicitation of clients or other activities for a period post-employment is very likely to fail.
For employees with a long and varied career within one company this distinction can be crucial. We recommend that employers consider the scope of the restraint clause each time an employee is promoted or changes duties. Whether or not an employee is issued with a fresh contract, could dictate whether the employer is protected at the end of employment.
The Length of the Restraint
In relation to non-compete and non-solicitation clauses, it is important to be realistic about what period of restraint will be required to sufficiently protect an interest. In the case of all but the very most senior employees, a three-month non-compete and a six-month solicitation is generally the most that a court will consider reasonable.
For senior employees, involving strong customer connections or highly sensitive information, consider a longer notice period, which allows the employee to be placed on garden leave. This can be used instead, or in concert with, an unpaid period of restraint. Courts have recognised that it is significantly more reasonable to restrain an employee if they are being paid their normal wage. Where the potential damage to the employer’s interest is material, then this is generally a small price to pay for protection.
How Big or Small an Area?
Some argue that geographical locations are no longer relevant to restraint clauses in a tech savvy and mobile world. However, most businesses still operate in a particular region, country, state, city or suburb. For non-competes, it is therefore still necessary to identify the scope of the area to be restrained.
When deciding how big or small the location covered, be reasonable. Whilst it might be tempting to cover off a large territory such as the Asia Pacific Region, you need to set your sights on something that will hold up if tested. Typically, the states or cities that clients, suppliers and/or direct reports will be based in and that the employee will be communicating with must form the basis of the area set. For more junior, or localised sales employees, an entire city will not be deemed reasonable, and it may be necessary to define the scope of the restraint by kilometre radius from the employer.
What happens if the Contract of Employment Fails?
Very few employers set out deliberately to breach their contractual obligations. However, it is nevertheless prudent to plan for the worst-case scenario. In NTIB v Howell, the NSW Supreme Court held that once a contract was repudiated by an employer, and the repudiation was accepted by the employee, their contractual obligations against solicitation and competition would be extinguished.
For this reason, those employers serious about protecting their interests may wish to think about a separate deed containing the post termination obligations. This will be unaffected by a repudiation of the employment contract. Deeds will be greatly strengthened by a payment of specific consideration in addition to the normal remuneration under the contract of employment. It is also worth considering vesting shares or share options to the employee rather than cash, as this has the added effect of giving the restraint a commercial element. Commercial arrangements have long been recognised as holding a higher threshold of enforceability than mere employment relationships.
It should also be noted that employers in New South Wales have a distinct advantage over employers in other states. The Restraint of Trade Act 1975 (NSW) allows a clause, if considered unreasonable, to be ‘read-down’ to a reasonable level. In other states, the entire reach of the provision is assessed, and if It goes beyond what is reasonable, the entire clause will fail.
For those operating outside of New South Wales, we recommend the use of severable, cascading clauses, which identify ranges of activity, time, and geographical area. If the more ambitious clauses are held to be unenforceable, then these can be ‘blue pencilled’ from the contract, leaving the remaining clauses enforceable. For national employers, if it is possible to make New South Wales the governing law of the contract, then this is strongly advisable.
Employees moving on is inevitable. When planning to protect your proprietary interests in this situation, the key considerations are:
- Be reasonable about your expectations on restraint, and focus on protecting the company’s interests, rather than punishing the employee for leaving. Restraints should not be taken as an opportunity to be vindictive towards a departing employee, even in situations where the departure is suspicious, or acrimonious. This achieves little, and an attempt to be too broad in a restraint, or too thorough in its enforcement, will almost always lead to the clause failing, or unnecessary legal expenses arising.
- Identify the confidential information and / or customer connection you are seeking to protect realistically and with as much particularity as possible.
- Re-assess your restraint provisions any time that an employee is promoted, or significantly changes the nature of their role.
- For employees with access to customers or sensitive information, provide a longer notice period to allow for garden leave when an employee resigns, and consider drafting a separate deed for post termination restraints.
- For senior employees, offering shares or equity as part of the remuneration package may also increase the reasonableness of longer restraints.
In this highly technical area of law, prevention is better than cure. Careful planning at the contract stage, and a small investment in a specialist legal advisor, can potentially save you thousands in legal fees and lost revenue should a restraint clause be either disputed or held to be unenforceable.