Restraint of Trade Clauses (NSW)
Restraint of trade clauses are often found in employment contracts and business sale contracts. They purport to prevent employees or vendors of new businesses from engaging in specific actions during or following their employment at the relevant company, or after they sell a new business. The purpose of these clauses is to protect various aspects of the employer’s or purchaser’s business.
Types of restraint of trade clauses
There are several different types of restraint of trade clauses. These all relate to the restraint of different activities. Some of these are:
- Relating to confidentiality. These clauses prevent employees from divulging, using or applying knowledge or information gained during their employment outside of the scope of that employment.
- Relating to competition. These clauses purport to prohibit employees from working for a competitor or starting a business that competes with the employer’s business.
- Relating to poaching employees or clients. These clauses purport to prevent an employee from encouraging employees or clients away from the employer after they leave the company.
- Relating to a business (sometimes called a goodwill restraint) that is sold will generally prevent the vendor from operating a similar business within a geographically defined area for a period of time.
Can they be enforced?
Whether restraint of trade clauses are enforceable depends on the particular facts and circumstances of each case. In general, such clauses are unenforceable unless it can be shown that they are reasonable. However, in New South Wales, this presumption is reversed under the Restraints of Trade Act 1976.
In New South Wales, instead of being presumed to be void and unenforceable, a restraint of trade clause is presumed to be valid. However, such a clause will only be upheld to the extent that it does not contradict public policy and is found to be reasonable. Under the Act, a court can “read down”, or adjust the scope of, a clause to ensure its effect is reasonable.
What is reasonable for a restraint of trade clause?
For a party to satisfy a court that the clause is reasonable, it must establish two things:
- That it is protecting a legitimate interest; and
- That its reach is reasonably necessary for protecting that legitimate interest.
Examples of legitimate interests include:
- Commercial interests such as confidential information that an employee could use and in doing so cause damage to the employer; and
- Goodwill in a company, including relationships that the company has with its customers.
How does a court determine what is a reasonable scope?
Factors that may be considered when determining whether the scope of a restraint of trade clause is reasonable include:
- The duration of time for which it is to last;
- The physical area over which it is to be imposed; and
- The actions that it restricts.
The clause can only be enforced to the extent that it is reasonable to protect the legitimate business interest to which it relates and does not go against public policy. If a restraint of trade clause is determined to be too wide in its scope, a court has the power to either declare the restraint of trade clause invalid, or of narrowing its scope so that it can only be partially enforced. Most of the time, a court will not find the restraint of trade clause invalid unless there is no legitimate basis for the restraint. Instead, what a court is more likely to do is “read down” the restraint of trade clause so that the restraint of trade clause operates to a lesser extent. An example of how a court may read down a restraint is by confining the operation of the clause to New South Wales rather than the whole of Australia. This may be done because the relevant company’s business is only in New South Wales and a restraint of trade clause that purports to cover the whole of Australia is too broad in scope.
In general, courts are more willing to enforce restraint of trade clauses that relate to goodwill related to the sale of a business rather than those restricting an employee’s activities. This is because the bargaining power between the vendor and purchaser of a business is usually more equal than between an employer and employee. Also, the vendor has usually received payment for observing the restraint of trade clause.
Restraint of trade clauses can be enforced through an injunction that is a formal order preventing the subject from engaging in the restraining activity. If a party that is subject to a clause breaches that clause, the party who is disadvantaged by the action can also bring a claim suing for damages for breach of contract.
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