Employers often use restraints of trade to try to stop employees from taking their confidential information to a competitor and gaining an unfair advantage over them. But just how enforceable are they?
A recent New South Wales Court of Appeal (NSWCA) found that whether a restraint of trade is enforceable depends on whether you’re trying to protect a legitimate interest, as well as factors such as their duration and an employee’s seniority.
The background to the case
The case started with a familiar scenario – a senior sales manager left his employer to work for a competitor. However, his employment contract contained three clauses: a confidentiality clause, an ‘exclusive employment clause’ (this said he must devote his time and attention to the employer during business hours and promote its best interests), and a restraint of trade.
The restraint of trade clause was one of the typical ‘cascading’ ones that employers sometimes use that allow for ‘12 months’, ‘9 months’, ‘6 months’, etc, in the hope that a court will enforce the most reasonable duration.
When the employee left and worked for a competitor, the employer alleged he broke all three of these clauses in his contract.
He then failed to comply with the notice of termination clause of the contract, which provided for three months that he would not work in direct competition. Instead, he started working for the competitor within four weeks of leaving. He also helped the competitor poach a more junior employee who was subject to a similar restraint of trade clause.
The former employer brought proceedings in the Supreme Court of NSW (the NSWSC) alleging the employee – and the employee he poached – had breached their employment contracts. It received interlocutory orders (that is, temporary orders), which prevented the employees from working for the competitor until the court decided the case.
The court eventually handed down a decision in the employer’s favour. It found:
- The employee breached his employment contract when he worked for the competitor within his three-month notice period.
- A nine-month restraint was reasonable and, therefore, enforceable in both contracts.
- The employee breached the ‘exclusive employment clause’ when he helped the competitor poach another employee.
The employee appealed the NSWSC’s decision in the NSW Court of Appeal.
The appeal: Are restraints of trade enforceable?
The Court of Appeal noted that restraints were only enforceable insofar as they protected an employer’s reasonable interests for a reasonable amount of time.
In this case, the employer had a legitimate interest in protecting its confidential information from a competitor, including its marketing plans and potential weaknesses in its product. As the employee was senior and privy to this information, it was, therefore, reasonable to restrain him from a competitor for nine months.
However, it also noted that the employee he helped poach was more junior and did not have any awareness of the company’s confidential information. It wasn’t reasonable to restrain him from working for a competitor because he could not damage its legitimate interest.
The Court of Appeal also found that the employee breached his notice of termination provision. He had also breached his contractual and fiduciary duties to his former employer when he helped poach the employee.
The Court of Appeal also found that because the competitor had encouraged the employee to breach his fiduciary duty, it, too, was liable.
What the case means for you as an employer
There are times you can rely on restraints of trade to protect your confidential information, but they need to be proportionate, and they can’t be used as a ‘catch all’ to try to limit who employees can work for. You’re also far more likely to find they’re enforceable against senior employees.
It’s always a good idea to have restraints drafted properly by your legal adviser. It’s also often a good idea to use ‘cascading’ clauses – based both on duration and geography – so that a court will enforce appropriate terms rather than ‘striking out’ an unreasonable restraint.
Also. if you’re hiring an employee from a competitor and they have a restraint, proceed with caution. If possible, have your legal adviser check their restraint over before you sign them up.
If you’d like to know more about restraints of trade, get in touch.
Alternatively, you can read the full decision here.