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Protecting Your Business Interests – The Importance of Getting it Right

14 December 2010

Protecting Your Business Interests – The Importance of Getting it Right

Nichola Constant, Director

Restraint of trade clauses attempt to protect the goodwill of a business by seeking to prevent former employees or owners from engaging in activities that compete with the business they have left.

Usually this involves a ‘Restraint of Trade’ provision in employment agreements, partnership agreements and sale of business agreements. These provisions seek to prevent departing employees or partners from taking clients, or competing with the business, for a period of time after they leave.

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 is no greater than required to protect that interest.

Drafting an enforceable restraint of trade clause in an employment contract first requires an understanding of the goodwill to be protected and how that goodwill was acquired. To protect the goodwill of a business, it is reasonable to place restrictions, for a period of time, on a former employee’s use of the business’ trade secrets and their access to the business’ customers with whom the former employee built up a relationship while employed by the business.

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) until it is reasonable.

In other states and territories, the Courts do not have this discretion. If a restraint clause is not ‘reasonable’ then a Court is likely to find the whole clause to be void and unenforceable. This is the main reason that ‘cascading’ provisions that cover a number of alternative time and geographical covenants are used. The advantage of these is that each one is intended to be severable by a Court without affecting the validity and enforceability of the restraint.

Stacks Taree v Marshall

On 1 March 2010, Justice McDougall delivered his judgment in the case of Stacks Taree v Marshall [No. 2] [2010] NSWSC 77.

Following his five-year employment as a solicitor at Stacks Taree, Mr Marshall was sued for breach of contract when he accepted a position with another law firm whose offices were located approximately 550 metres from the offices of Stacks. A term of Mr Marshall’s employment contract at Stacks prohibited him from soliciting clients of the firm and from practicing as a solicitor within a ten-kilometre radius of the Post Offices at Taree and Wingham for a period of twelve months after the termination of his employment.

While the Court held that a restraint of 12 months was reasonable to protect the legitimate interests of the employer, it read down the restraint to apply only to clients with whom the employee had contact during the final 12 months of his employment.

In reaching this conclusion, the Court had particular regard to Stacks being a third generation law firm practicing in the Taree and Wingham areas which had cultivated its reputation over a period of eighty years so that it was unlikely that Mr Marshall’s departure from the firm would have any significant impact on the presence of Stacks in the local business community of Taree. Further, in the circumstances, the restraint of trade covenant that Stacks sought to enforce went beyond the legitimate interest of protecting their goodwill.

In addition, the Court held that the restraint prohibiting the employee from engaging in “competitive activity” was not enforceable because it was a restraint against mere competition and, at common law, an employer is not entitled to protection against mere competition.

For the above reasons the application for enforcement of the restraint of trade covenant was dismissed and Stacks was ordered to pay Mr Marshall’s costs.

OAMPS Insurance Brokers Ltd v Hanna

In another recent Supreme Court of New South Wales decision, OAMPS Insurance Brokers Ltd v Hanna [2010] NSWSC 781, the Court considered the validity of cascading clauses.

Mr Hanna was an insurance broker who had been employed by OAMPS for 19 years. OAMPS sells insurance policies to clients and earns revenue by commission. Because of the nature of the business, the personal relationship between an employee and the client’s representative was seen as an important factor in client retention for OAMPS.

On 30 September 2008, while Mr Hanna was still employed by OAMPS, he signed a written employment contract, a schedule to which contained a post-employment restraint deed (the “Deed”).

The restraint period and restraint area were drafted as cascading and cumulative clauses, meaning that each of the restraint areas and time periods were intended to work together. The widest intended restraint was Australia- wide for 15 months, and the narrowest restraint was in Sydney for 12 months. There were nine combinations of restraint areas and time periods in total.

After being approached by a competitor, Strathearn, Hanna resigned from OAMPS and began working immediately for Strathearn. Subsequently, Mr Hanna was contacted by three OAMPS’ clients who moved their business to Strathearn.

OAMPS claimed that Mr Hanna had breached the Deed and sought an injunction to prevent Mr Hanna from providing services to a specified list of clients for a period of 15 months.

Mr Hanna claimed the Deed was void because of the uncertainty of the scope of the restraint “by virtue of its cascading nature”. Furthermore, he claimed he had not solicited any of OAMPS’ clients, and any information he had of their previous insurance and their business needs was information that was volunteered by the clients.

While noting that the case law on cascading clauses had been inconsistent, Justice Hammerschlag stated that he was bound to follow JQAT Pty Ltd v Storm [1987] 2 Qd R 162 (“JQAT”) unless he considered it to be clearly wrong. He found that the Court in JQAT held that a cascading provision in a restraint of trade clause is valid and certain if each individual restraint covenant is:

  • expressed in clear words;
  • is capable of simultaneous compliance; and
  • does not require any inquiry or finding by the Court to make it operative.

Justice Hammerschlag was satisfied that these criteria had been met, and therefore the Deed was not void due to uncertainty.

He also noted that the Deed, as a whole, indicated that the widest enforceable covenant was intended. While the court is able to sever the provision with the widest scope if it deems it unreasonable and unenforceable, Justice Hammerschlag pointed out that considerable weight should be given to the period as agreed between the parties, namely the maximum specified period.

OAMPS argued that as every policy was renewable within 12 months from Hanna’s departure, a 15 month restraint was the minimum period to ensure them a proper opportunity of not less than three months across the portfolio to protect its customer connection.

His Honour held that the restraint was reasonable due to the strong relationships that Hanna had maintained with OAMPS’ clients. At the time the deed was made, Hanna had been an employee at OAMPS for 19 years, during which time he had built and nurtured client relationships. Justice Hammerschlag found that because the length of most insurance policies is 12 months, this was the reasonable time needed to sever the relationship between Hanna and OAMPS’ clients.

The Appeal – Hanna v OAMPS Insurance Brokers Ltd [2010] NSWCA 267

On 19 October 2010, the New South Wales Court of Appeal dismissed Mr Hanna’s appeal (Hanna v OAMPS Insurance Brokers Ltd [2010] NSWCA 267) upholding Justice Hammerschlag’s decision.

Lessons for Employers

So when will post-employment restraints of trade be enforced?

The Supreme Court of NSW in Stacks Taree v Marshall and the New South Wales Court of Appeal in Hanna v OAMPS Insurance Brokers Ltd, have reinforced that post-employment restraints of trade will be enforced where the covenant is protecting the former employer’s legitimate interest, and where the covenant is reasonable in scope and properly drafted.

Further, it appears that the courts will uphold the judgment in JQAT regarding cascading provisions, and deem them to be valid insofar as the obligations are not mutually inconsistent.

OAMPS reinforces that employers whose post-termination restraints include cascading provisions must ensure that the provisions include clear language that each permutation of the restraint is separate, independent and severable from all other permutations to avoid them being void for uncertainty and unenforceable.

Both decisions are useful guides to assist employers in drafting appropriately worded restraint covenants. However, the exact wording used in post-employment restraint covenants is critical to an employer’s ability to persuade a Court to enforce them.

Your Key Actions:

    1. Genuine Interest – first, to restrain another person, an employer 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. Cascading Clauses – alternative time periods and geographic areas may help to ‘hedge your bets’.

Employers must 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 of your business, they are likely to be void and unenforceable. There is little point having an agreement in place if you cannot enforce it when necessary

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