Restrictive Covenant
Discuss about the Contract and Corporation Law for AGA Assistance Australia.
Every business organization has information that the organization considers both priceless and fundamental to its success. After the termination of the employment of the employees, the employers usually restrict the use of such information by such ex-employees. The employers often incorporate these restrictions within the employment contracts and by signing such restrictive covenants; they agree not to do certain things after the expiry of the employment. The employers impose these restrictions to safeguard themselves by preventing the former employees from using the information and knowledge that they gained during their employment so that they are unable to benefit from their new jobs[1].
A restrictive covenant is a contractual clause that prohibits an employee from competing with his ex-employer for a certain period after the expiry of the employment or restricts the ex-employee from dealing or soliciting with customers of the business organization with the help of the knowledge that the ex-employees have gained during the course of the employment[2]. The employers may use the following standard types of restrictions in the employment contract:
- Non-competition covenants- the former employees are prohibited from directly competing with their ex-employers within a specific geographical and/or for a particular time-period. It is incorporated in the employment contract as non-compete clause[3].
- Non-dealing clause- this clause prevents an ex-employee from working for the clients, suppliers and customers of the former the organization for a stipulated time –period.
- Non-poaching clause- this clause restricts an ex-employee from enticing the staffs of the ex-organization away from that organization for a stipulated time-period.
The Australian employers use the restraint trade clauses in the employment contracts particularly for senior/managerial and professional employees[4]. In order to enforce the restrictive covenant the onus of proof is on the employer to establish that the clause is sufficiently narrow and justified. In order to justify the restrictive clause, the employer must consider the following factors:
- The breadth of the geographical area must be justifiable;
- The duration of the restriction more than 6-12 months would be difficult to justify;
- The activities that the employer attempts to restrict;
- The type of interest the employer is attempting to restrict;
The restrictive covenants shall be enforceable only if the employer succeeds in establishing the fact that the restrictions are:
- reasonable;
- no longer than is necessary to safeguard the interest; and
- necessary to safeguard the legal business interests;
A restrictive clause cannot be accepted unless the court considers such clause reasonable. In Buckley v Tutty [1971], the High Court of Australia held that unreasonable restrictive clauses is unenforceable as it is against the welfare of the public that a person should be unnecessarily restricted from earning a living in any legal way as he chooses as long as the way is legal. It is unreasonable to deprive the public from the services of such person. In order to assess whether the restrictive clause in an employment contract is reasonable or not, the court shall consider the duration of the restrictive clauses, the geographical area in which the clause shall apply and the activities of the employee the clause tends to control[5]. The extent of restrictive covenants is related to the position of the employee within the business of the organization. The employers usually include such restrictive clause in the employment contract of the employees who occupied higher or senior position in the organization. The rationale behind the notion is that a senior employee is in contact with information that is more sensitive by nature and the restrictive clause is justified[6].
The employers cannot use the restrictive clause to safeguard themselves against the normal processes of competition in a market. Legitimate interests that usually support a valid restraint include trade secrets or confidential information about the employer or the organization, information about the customers or clients and the staffs of the employer. In AGA Assistance Australia Pty Ltd v Tokody [2012], the court held that the restrictive clause with respect to the duration of the restriction was reasonable, as 12 months duration was a reasonable time-period to safeguard the legitimate interests of the employer.
Safeguarding Genuine Interests
Moreover, it is necessary to incorporate restrictive clauses in the employment contract with respect to the confidential information related to the organization, staffs or the clients and customers of the organization. There is an inherent protection that the former employees shall disclose or take unfair advantage of the confidential information unless such clause is expressly mentioned in the contract[7]. If an employer wants to prohibit any former employee from competing with the former organization or dealing with the customers of the organization, the employer must specify such restrictions in the employment contract in clear words and must include justified reasons for including such clause[8].
Application of Laws and Conclusion
In the given scenario, Chu has been employed in the position of Operations Manager of Computers Pty Ltd, a company that retails computer hardware and software. Due to senior position of Chu, he was well aware of the identity and the requirements of the clients of the company. At the time of retiring from the organization, he agreed to the non-compete clause expressly specified in the employment contract of the company that prohibited him from competing against the company in New South Wales for a stipulated period of 2 years. He retired in March 2014 and in April 2014 Systems Pty Ltd came into incorporation that was engaged in the retail business of selling computer hardware and software. Chu’s wife holds the issued capital in the company and is the only director of the company. The company solicits business from the clients of the Computers Pty ltd in New South Wales.
As explained earlier, that a restrictive covenant is a contractual clause that prohibits an employee from competing with his ex-employer for a certain period after the expiry of the employment. It restricts the ex-employee from dealing or soliciting with customers of the business organization with the help of the knowledge that the ex-employees have gained during the course of the employment[9]. Now, at the time of retiring from the employment, Chu signed the employment contract that included a restrictive clause according to which he is prevented from competing against the former business for a period of 2 years. However, Chu’s wife being the director of the Systems Pty Ltd was soliciting the customers of the Computers Pty Ltd.
The restrictive clause in the employment contract prohibited Chu from competing against the business for two years. The employment contract did not contain any restrictive clause regarding dealing or soliciting with the customers of the Computers Pty Ltd. There is an inherent protection that the former employees shall take unfair advantage of the confidential information unless such clause is expressly mentioned in the contract. If an employer wants to prohibit any former employee from competing with the former organization or dealing with the customers of the organization, the employer must specify such restrictions in the employment contract in clear words and must include justified reasons for including such clause[10].
Further, in order to enforce any restrictive clause the employer must establish that such clause is reasonable; it safeguards the legitimate interests of the business and that the duration of such clause is not more than what is necessary to protect the interests of the business. Furthermore, the duration of the restrictive clauses must not be longer to the extent that it would prohibit the employees from exhibiting their skill and talent to earn their living and deprive the public of their services.
In the given case, Computers Pty ltd has included in the restrictive clause that Chu shall be prohibited from competing against the company in New South Wales for the stipulated period of 2 years. In AGA Assistance Australia Pty Ltd the court held that a duration of 12 months is reasonable in order to safeguard the legitimate business interest. In case the duration of the restrictive clause is more than 12 months or longer, the burden of proof is on the employer to establish that such duration is reasonable and justified as it protects the legitimate business interest of the organization.
In order to justify the restrictive clause, the employer must further establish that the activities that the employer attempts to restrict are justified and the type of interest the employer is attempting to restrict is also justifiable and is not unreasonable. In this case, since the Computers Pty Ltd did not include a restrictive clause pertaining to the dealing and soliciting with the customers of the organization, it cannot bring any legal action against Systems Pty Ltd. The restrictive clause simply prohibited Chu from competing with the business and not from dealing with the customers of Computers Pty.
Therefore, Computers Pty Ltd cannot bring any legal action against Systems Pty Ltd for soliciting with its customers but may become entitled to claim damages or injunctions only if it is establishes that the duration of the restrictive clause is justified and reasonable.
AGA Assistance Australia Pty Ltd v Tokody [2012]
Ash, Abraham, and Elodie Cheesman. “Employment: Post-employment restraint after repudiation of an employment contract.” LSJ: Law Society of NSW Journal 21 (2016): 76.
Buckley v Tutty [1971] 125 CLR 353
Buenstorf, Guido, et al. “Non-compete clauses, employee effort and spin-off entrepreneurship: A laboratory experiment.” Research Policy 45.10 (2016): 2113-2124.
Chia, Hui Xian, and Ian Ramsay. “Employment Restraints of Trade: An Empirical Study of Australian Court Judgments.” (2016).
Davis, Angie, Eric D. Reicin, and Marisa Warren. “Developing Trends in Non-Compete Agreements and Other Restrictive Covenants.” ABA Journal of Labor & Employment Law 30.2 (2015): 255.
Murphy, Tonia Hap. “Covenants Not to Compete in Employment Contracts: Worth a Closer Look in the Classroom.” Journal of Legal Studies Education 32.1 (2015): 131-171.
Rauch, James E. “Dynastic entrepreneurship, entry, and non-compete enforcement.” European Economic Review 86 (2016): 188-201.
Sandeen, Sharon K., and Elizabeth A. Rowe. “Debating Employee Non-Competes and Trade Secrets.” (2017).
Selmi, Michael. “Trending and the Restatement of Employment Law’s Provisions on Employee Mobility.” Cornell L. Rev. 100 (2014): 1369.
Srinivasan, Varun. “Restraint of Trade: Emerging Trends.” (2015).
Thomas, Randall S., Norman Bishara, and Kenneth J. Martin. “An empirical analysis of non-competition clauses and other restrictive post-employment covenants.” (2014).
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