How do courts enforce restraint of trade clauses?
Following on from our earlier article regarding Preserving your business through restraint of trade clauses, the New South Wales Supreme Court has recently handed down a decision which provides valuable insight into the approach that the judiciary takes to enforcing restraint of trade clauses.
Seven Network (Operations) Ltd 7 ors v James Warburton (No 2)  NSWSC 386
James Warburton, a highly skilled and talented television executive, was employed by the Seven Network [Seven] as the Chief Sales & Digital Officer under a fixed term contract due to expire on 14 October 2011.
Mr Warburton was considered the natural successor as Chief Executive Officer of Seven but seized an opportunity to become the Chief Executive Officer at Network 10 with a commencement date of 14 July 2011. Having accepted this offer on 2 March 2011 and communicated the situation to Seven, they reacted by requiring Mr Warburton to leave their premises and sought to enforce a restraint of trade clause, which prevented him from working for Network 10 for a period of 12 months from the date that he “ceases to be employed or engaged” by Seven.
First Issue – When Does the Restraint Period Begin Operation?
The first issue which was considered, concerned the date when the restraint period commenced.
Seven asserted that the twelve month restraint period should commence from the expiry of the fixed term contract on 14 October 2011. Conversely, Mr Warburton argued that if the restraint was valid, the restraint period should start from 2 March 2011, being the date that Seven required him to leave their premises and refrain from performing all duties.
Justice Pembroke of the NSW Supreme Court reasoned that if he approved the Seven’s argument, it would mean that the restraint would operate for a period of 19 months, being the period of 12 months from the expiry of the contract on 14 October 2011, rather than the intended 12 months. Given that Mr Warburton had been placed on “gardening leave” (i.e. a period where the employee is sent home and not required to perform work during the notice period) by Seven, this would lead to an unreasonable result because he had no access to confidential information or the clients of Seven from this date.
Accordingly, his Honour found in favour of Mr Warburton on this point by holding that as he had ceased employment in a practical sense from the date he was placed on gardening leave, and as the parties intended the restraint period to operate for 12 months, the restraint period started from the date he was placed on gardening leave, being 2 March 2011.
Second Issue – Is the Restraint of Trade Clause Valid?
One of the key issues considered in a matter concerning a restraint of trade clause, is, whether it is in fact valid and enforceable. The central principle which governs this exercise is that a restraint will not be enforced unless it is necessary for the reasonable protection of the employer’s legitimate interests.
In this decision, his Honour initially sought to ascertain whether the restraint was reasonable at the time it was agreed between the parties. His Honour found that it was reasonable having regard to the following factors:
- The restraint derived from an equity participation deed entered into between managerial employees and Seven. The object of this restraint was to reduce the risk of devaluation of the business by the departure of any executives to competitors; to reduce the risk of the misuse of confidential information by competitors; and to reduce the risk of dissipation in the customer connection of the business.
- Mr Warburton acknowledged the reasonableness of the restraint by signing the equity participation deed and was well aware of the effect of the restraint as he had received independent legal advice.
- The majority of the Seven’s advertising revenue is generated from five agency buying groups. The contracts for four of those agency buying groups are negotiated on an annual basis commencing in September and concluding in November/December. Mr Warburton had access to the confidential information used in negotiating these contracts, namely the differential rates and trading terms entered with the agency buying groups. This twelve month business cycle explained the commercial reason behind selecting a 12 month restraint period.
After concluding that the restraint was reasonable, his Honour observed that it is an entirely different question as to whether it will be enforced for the entire restraint period. Further, his Honour ordered that the restraint be enforced only until 1 January 2012 because of the following factors:
- During the period between March and 31 December 2011, Seven can be expected to finalise the contracts with four of the five agency buying groups and, hence, Mr Warburton will no longer have knowledge of these contracts when he commences negotiating with these agency buying groups on behalf of Network 10 in 2012.
- There is no realistic concern regarding customer connection because this is not an industry where senior executives “carry their employer’s customers in their back pocket”.
- Although it may appear unusual that his Honour refused to enforce a contractual term which was found to be reasonable, the underlying principle must be remembered that a restraint will only be enforced to the extent that it protects the employer’s legitimate interests.
Lessons for Employers
Employers need to be aware that if they choose to place an employee on gardening leave, it may (depending on the terms of the restraint clause) and surrounding circumstances, be taken into account by the court in determining the appropriateness of any restraint period. Secondly, employers must understand that although they have agreed to a restraint with an employee, it does not necessarily follow that a court will enforce it to its full effect, because a restraint will only be enforced to the extent that it is necessary to protect the employer’s legitimate interests.
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