Restraint of Trade
Business owners, in an attempt to protect the goodwillof their business will often include ‘Restraint of Trade’provisions in employment agreements, partnershipagreements and sale of business agreements. ‘Standard’clauses are often used instead of tailoring a clause tosuit the specific circumstances
What are ‘restraint of trade’ clauses?
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.
What are the risks?
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 (as to the time period or geographic area etc) until it is reasonable.
What must you do to ensure a restraint clause can be relied upon?
From the numerous cases that have dealt with restraint clauses, the requirements for a restraint to be held reasonable are:
1. Genuine Interest – first, to restrain another person, you must have a genuine and legitimate interest that needs protecting and secondly, the restraint should be limited to protecting that interest;
2. Time Period – the restraint should not be for a time period that is longer than necessary to protect that interest;
3. Geographic Area – the restraint should not cover a geographical area that is larger than necessary to protect that interest;
4. For Employees – take particular care to ensure that the restraint is not so broad as to prevent the employee form working at all; and
5. Cascading Clauses – with alternative time periods and geographic areas may help to ‘hedge your bets’.
Therefore it is critical to identify precisely what interest needs to be protected and in what area and for what time and then limit the restriction to that. Be wary of any so-called ’standard’ clauses. If they do not suit the specific circumstances, they are likely to be void and unable to be enforced. There is little point having an agreement in place if you cannot enforce it when necessary.