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14 June 2012 Enforcing Trade Restraints - Two year restraint can be reasonable

By Richard Ottley, Partner and Nathan Huynh, Law Clerk

Introduction

Employers commonly include restraint of trade clauses in contracts of employment to seek to protect themselves from their employees poaching their clients or staff, or for working for a competitor.

At common law, restraints are contrary to public policy and are therefore prima facie void, unless they can be shown to be reasonably necessary to protect the legitimate interests of the person seeking to enforce them.

The enforcement of restraints is problematic given the fact that decisions in this area are heavily influenced by the unique circumstances of each case. The outcome of a case may depend upon a court's perception of the threat to the business posed by the former employee and whether the restraints in question were confined to what was reasonably necessary to protect the legitimate business interests of the person seeking protection. How long a restraint may be enforced for, is a particularly elusive matter to predict, and few restraints in the employment context are enforced beyond 12 months. However a recent decision in the Federal Court suggests that there are some circumstances in which a restraint of 24 months may be enforced.

HRX Holdings Pty Ltd v Pearson [2012] FCA 161

Brent Pearson was a director and employee of HRX Holdings Pty Ltd ('HRX'), a Human Resources outsourcing company. He was also a co-founder of the business with Katrina Leslie. He was employed under a formal written contract which included a provision restraining him from accepting employment or engaging in a business "similar to or competitive with" HRX for a period of two years from cessation of employment with HRX.

The Agreement also gave Mr Pearson an 8% stake in the company and an arrangement for the payment of his past-average remuneration for all but three months of the restraint period. The defendant resigned from his directorship in July 2011 and sought to take employment at a senior level with one of HRX's major competitors. An injunction was granted enforcing the two-year restraint provision on the basis that the restraints were reasonable in the circumstances.

First Issue – Was the scope of the restraint was reasonable?

In determining the validity of the restraint, Justice Buchanan considered the reasonableness of the scope of the restraint. The Agreement defined a restrained business as "a business or operation similar to or competitive with the business of a group company".

The defendant argued that the words 'similar to' were impermissibly wide because they were not confined to present or potential competition and were not subject to any stated geographical limitation, and that no such limits should be implied. The defendant also argued that the restraint was impermissibly wide because it was not limited to the legitimate and reasonable protection of HRX.

However his honour held that the scope of the restraint was not unreasonable, noting that the evident purpose of the clause was not to unnecessarily restrain the legitimate future of the defendant, but rather to provide reasonable and legitimate protection to HRX Holdings in areas in which the business was operating.

Second Issue – Was the duration of the restraint reasonable?

Justice Buchanan also considered the reasonableness of the two-year duration of the restraint and found that a two-year restraint was reasonable in the circumstances in question. 

He noted that the duration of the post-employment restraint had been the subject of close negotiation. The issuance of shares and the arrangement for payment to the defendant for all but three months of the restraint period, were provisions included in the Executive Service Agreement to specifically address the restraint period.

He held there was separate consideration for the restraint period and that it was 'clearly valuable consideration'.

His honour also found that because HRX typically entered into two or three year contracts with its clients, a period of two years reasonably accommodated HRX's contractual cycle and was reasonable in preventing the defendant from intruding on HRX's efforts to renew or extend existing contracts. 

It is also interesting to note that no other HRX executive had a provision in their employment which provided for payment during the restraint period.      

Third Issue – Is the Restraint Act inconsistent with the Fair Work Act?

Justice Buchanan also noted that if the above conclusions as to enforceability were incorrect, an application of the (NSW) Restraints of Trade Act would lead to an identical conclusion. The Restraint of Trade Act allows a restraint to be read down in NSW, to make it enforceable in circumstances where it might otherwise fail because it is too broad, (provided that a reasonable attempt had been made when drafting it in the first place).

The defendant also argued that s26 of the Fair Work Act has the effect of excluding all state industrial laws thus making the Restraint of Trade Act inoperative. However Justice Buchanan held that the Restraints Act related to the enforcement of contracts of employment which are classified as a 'non-excluded' matter under s27 of the Fair Work Act, and therefore not displaced by the Fair Work Act. His honour also held that s26 would also not apply as the Restraint of Trade Act was not an "industrial law".  

Lesson for employers

Generally a two-year restraint provision will be regarded as extending beyond what is reasonably necessary to protect the legitimate business interests of the employer. However in some circumstances, including dedicated consideration for the restraint, and a two year contract cycle, courts are prepared to look at enforcing restraints for periods exceeding a year.

Richard Ottley, Partner  |  Phone: +61 2 9233 5544  |  Email: rbo@swaab.com.au

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This article is not legal advice and the views and comments are of a general nature only. This article is not to be relied upon in substitution for detailed legal advice.

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