Restraint of Trade: Be wary of ‘standard’ clauses

Business owners, in an attempt to protect the goodwill of their business will often include ‘Restraint of Trade’ provisions in employment agreements, partnership agreements and sale of business agreements. ‘Standard’ clauses are often used instead of tailoring a clause to suit the specific circumstances. In the last six months alone, there have been at least half a dozen cases in Australia dealing with restraints and whether or not they can be enforced. All of the cases highlight the importance of getting the wording right or risk losing the benefit of such a clause.

They are a means for employers and partnerships to prevent departing employees or partners from taking clients or competing with the business for a period of time after they leave. They can be very important particularly for businesses that rely on client relationships.

Restraint of trade clauses are also used by people buying a business to stop the seller from starting up a competing business immediately after the sale.

Usually the courts will be less likely to uphold a restraint between an employer and employee than one preventing a seller setting up in competition. This is because an employee restraint is effectively preventing an employee from working in his or her chosen field whereas a restraint in a business sale agreement can benefit both the seller and purchaser. It can benefit the purchaser by restraining the seller from competing with the purchaser after the sale and it can benefit the seller as the giving of a restraint often increases the value of what is sold.

Courts will usually only enforce restraint clauses if they are ‘reasonable’. In New South Wales, the Restraints of Trade Act 1974 allows a court to ‘read down’ the terms of a restraint clause to modify it, for example to the time period or geographic area, until it is reasonable.

However in other states and territories, the courts do not have this discretion. Therefore if a restraint clause is not ‘reasonable’ then a court will usually find the whole clause to be void and unenforceable. This is why you often see restraint clauses with ‘cascading’ provisions that cover a number of alternatives. For example, the clause may say that the restraint is for one, two or three years and cover Brisbane, Queensland or Australia, whichever is reasonable. This allows a court to pick whichever scenario is ‘reasonable’ and avoid the whole clause from being held unenforceable.

In deciding whether a restraint is reasonable, the courts will look at whether the restraint protects a genuine interest of the restrainer and whether the time period and geographical area are no greater than required to protect that interest. The results of some recent cases are:

Austress-Freyssinet sought to restrain its former managing director and shareholder, Mr Kowalski from exercising any rights as a director and shareholder of the company he subsequently joined, NT Pre-Stressing, which was engaged in the same type of business as Austress. The restraint clause was in a shareholders agreement. The restraint prevented Mr Kowalski from being involved, which included being a shareholder, in any business which was the same or similar to Austress, was unlimited as to geographic area and included three alternative time periods of three years, two years and one year. In this case it was found that: