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22 February 2017 How to lose a business - without lifting a finger

By Warwick Ryan, Partner

'The shareholders own the business, right?  After all, they own the company, which pays the rent and the staff and the bills that keep the lights on and the photocopier humming. The customers are customers of the business, aren't they? Sure, your employees have the direct relationship with the customers, but the customers belong to the business…don't they?

Well, maybe not.

Let's remember that the real value of many businesses lies in their relationships with customers (rather than plant and equipment). In these businesses, it's the people who 'own' those customer relationships who effectively own the revenue – thus the business itself.  If those key employees are free to waltz off and take those relationships with them (ie if they are not bound by post-employment restraints) it's questionable whether the company (practically) owns anything, except possibly some stock in the warehouse.  This is not just a theoretical issue - we have been asked for advice by many employers whose businesses have been destroyed when a key employee has walked out of the door taking the business's customers with them - and leaving the employer with little but fixed costs and a remnant customer base barely capable of servicing those costs. 

The situation is similar in many 'knowledge-based' businesses – if an employee with knowledge of key-processes moves on and immediately sets up in competition, the effects of this 'reverse Trojan horse' may be devastating for the former employer's business.

So if I am working in a 'relationship' or 'knowledge' business where the key staff are not bound by restraints, my job (and that of many other employees) could be a casualty if those staff leave and take crucial business relationships and knowhow with them. I'd say that's a reason to care!

'There's nothing that can really be done in practice, right?'

For some reason, there's an employment law myth that post-employment restraints are unenforceable and that former employees are at liberty to go on to do whatever they like – including taking customers with them.

But the reality is different. In fact, courts routinely issue injunctions against ex-employees limiting their activities after termination – and businesses and their owners receive the protection they seek.  For example:

A 12 month ban on approaching customers

A former employee of a labour hire company who had worked for a single client (the Queensland Government) for a number of years was restrained from working for the same client via another labour hire company. The employee's contract contained a commonly used non-solicitation clause preventing the worker from being able to "solicit, canvas, deal with or approach any person… who… was provided with goods or services by… [the former employer]" for 12 months after leaving.  The restraint was upheld by the court.

Importantly, there was nothing unusual about this decision; rather it followed a long line of such decisions by courts where properly drafted post-employment clauses are upheld. So businesses can protect themselves with effective restraints which can be enforced for extended periods and in a meaningful way. 

Please Sir, Can I have some more?

A 6 or 12 month restraint is not unusual – but the courts seldom enforce employment contract restraints for a period longer than 12 months. Usually, the restraint is limited to not-soliciting or dealing with customers.  (As, in an employment situation, the court will rarely make an order enforcing a complete non-competition clause.) 

So, is it possible to restrain an employee for a much longer period after they leave? How do you protect the business's legitimate interests and prevent former employees from exploiting their business relationships or knowledge for a longer period if that is what your business needs?

The answers are Yes – maybe and Sometimes all it takes is to put some thought into the way the employee is engaged by the business.

 

If the employer is a private company - offer the employee shares. The shareholding has to be meaningful and not token – but you can then tie the employee up with a robust restraint (including non-competition provisions) in a shareholders' agreement.  And that restraint can survive any sale of the company – protecting the value of the business for the major vendor shareholder and the buyer (and, in the process, the transferring employees).  For example:

5+ years

In a recent case, the court considered the length of restraints that were enforceable against the former Managing Director/owner of an engineering firm which had been sold. Over $500,000 was paid for goodwill and the court decided (in a decision at an initial stage anyway) that it is willing to entertain a restraint applying for 10 years.

If it works, why not use it?

Maybe it is time for your business to think very carefully about the current arrangements for restraining key employees post-employment. You probably owe it to the shareholders and the other staff to make sure key staff are properly restrained from damaging the company when they leave.  After all, without effective post-employment restraint clauses – who really owns the business?


This article was first published on LinkedIn as a blog. You can read the original here.


 

Warwick Ryan, Partner  |  Phone: +61 2 9233 5544  |  Email: wpr@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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