Restraining the conduct of former employees

Restraining the conduct of former employees

By Leonie Kyriacou

May 10, 2013

Key points

  • There is a recent trend among courts in different jurisdictions to uphold the validity of employment restraints.
  • Despite the recent trend, courts continue to require that restraints are very carefully drafted to focus only on the legitimate business interests to be protected having regard to the type of work the employee performs.

Why restraints matter

There are few things in business as troubling and potentially costly as discovering that your most valued and trusted employee has resigned to work for your main competitor or to establish their own business in competition with you.  This scenario presents tangible risks including loss of your confidential information including any trade secrets, poaching remaining staff and, perhaps most troubling, the loss of existing clients.

Given such risks, restraint of trade clauses in employment contracts have become extremely common.  In fact, as an employment lawyer it is one of the most common things I am asked to advise upon.

Recent trends

In the past, the news for employers has not been good.

Courts have been notoriously reluctant to enforce such clauses even in circumstances where the conduct of the exiting employee has led to genuine and significant losses for the employer.  The reason for the court’s reluctance to assist employers stems from the fact that restraint clauses are prima facie void because they are against public policy.  Courts will uphold these clauses only to the limited extent that the employer has a legitimate interest to protect and the terms of the restraint are reasonable in all the circumstances.  The position is somewhat different in New South Wales by virtue of the Restraints of Trade Act 1976, which provides that a restraint of trade is valid to the extent that it is not against public policy. Nevertheless, all too often employers require restraints which go well beyond the critical activities or information they are trying to protect and prevent the employee from being able to go about the business of earning a living in their chosen field.

However, a number of recent decisions mean that perhaps the tide is turning.  In these cases employers have succeeded in restraining exiting employees through the use of carefully drafted restraints.  These cases hold important lessons for employers about the types of restraints that will be effective.

Briefly, in the case of Seven Network (Operations) Limited v Warburton (No 2) [2011] NSWSC 386, the Supreme Court of NSW upheld the right of the Seven Network to restrain Mr Warburton from accepting a job as CEO of channel 10 for a period of 12 months (made up of a period of gardening leave and a separate restraint).  While employed as the Chief Sales and Digital Officer for Channel Seven, Mr Warburton entered into a separate “Management Equity Participation” deed with his employer.  This deed included a cascading restraint clause to apply after the termination of his employment but it also included a grant of valuable equity benefits to Mr Warburton.  The Court found that Mr Warburton only agreed to the deed after taking proper legal advice.

A cascading restraint is a technique lawyers adopt when drafting restraints.  It seeks to provide various alternatives to elements of the restraint such as to the length of time for which the restraint applies or the geographical area it covers.  If drafted correctly (as this clause was) it allows the Court to strike out options in the cascading clause that are held to be too onerous or broad whilst leaving the remainder of the clause intact and enforceable.

In this case, the Court’s decision to uphold the restraint was based on matters including:

  • the fact that Mr Warburton was given valuable consideration in exchange for the restraint; and
  • Mr Warburton first having had proper legal advice.

That is, the Court held that Mr Warburton was aware of what he was agreeing to and was paid handsomely for that agreement.

The case also demonstrates that gardening leave can be an effective tool which works in conjunction with a restraint.  Gardening leave is the practice of requiring that an employee stay away from work during their notice period after their resignation or termination whilst still remaining on the payroll.

In the case of HRX Holdings Pty Limited v Pearson [2012] FCA 161, the Federal Court upheld a restraint which applied to an executive recruitment consultant.  In that case, Mr Pearson (the employee) had a well known and special ability to attract clients.  The employer was aware of the employee’s skills and so to protect itself it had him enter into a separate agreement restraining his post employment conduct.  Like the agreement in the Channel Seven case, this separate restraint also granted the employee a payment in exchange for the restraint.  The payment was equivalent to the employee’s salary for the period of the restraint. An appeal against the decision by Mr Pearson to the Full Federal Court was dismissed.

Similarly, in the matter of Birdanco Nominees Pty Limited v Money [2012] VSCA 64, the Victorian Court of Appeal upheld a restraint which applied to a relatively junior accounting employee.  In that case, the restraint was limited.  It only prevented the employee from providing accounting services to those clients of the employers for whom the employee had provided such services in the final three years of his employment.  That is, it did not seek to restrict him from working (or soliciting work from) clients of the employer for whom he had never directly worked.  In that case, the employee tried to argue that he only held a junior position so should not be restrained in any way.  Interestingly, the Court of Appeal rejected this argument because it held that having regard to all the circumstances and the limited application of the restraint, it was reasonable and not onerous.

Finally in the decision of Planet Fitness Pty Limited v Brooke Dunlop & Ors [2012] NSWSC 1425, the Supreme Court of NSW considered a restraint which applied to a personal trainer who was an independent contractor with Planet Fitness.  She was subject to a three month restraint preventing her from “directly or indirectly” soliciting the business of anyone who was a client of Planet Fitness.  Perhaps unsurprisingly, after her relationship with Planet Fitness ended, Ms Dunlop was engaged by other gyms (who were also sued in the case) and those gyms began offering discounts to people she had previously trained.  She also posted messages to her Facebook page updating her new work details and advising of the various “deals” on offer.  Many of her Facebook friends were clients of Planet Fitness.

The case includes a detailed consideration of what it means to “solicit” work.  The Court noted that in many cases it will be the client who first initiates the contact but what occurs next can be relevant.  The Court also held that the status of the client’s relationship with the existing employer was relevant.  Ultimately, the Court was satisfied that Ms Dunlop had breached her restraint and ordered her to cease from any further attempts to solicit custom from clients of Planet Fitness.

From an employer’s perspective, these cases demonstrate that restraints can be used to prevent certain competition from ex-employees but only if drafted correctly.

Important Lessons for Employers

The employers succeeded in these cases because the restraints went no further than what was necessary to protect the legitimate business interests of the employer.  The restraints did not seek to cover the field unless valuable consideration was paid to the employee.

It is a timely reminder to look at the arrangements you have in place and determine precisely what risk (if any) an employee’s termination would pose to your business.  If such a risk exists it is critical to determine the nature of that risk and ensure that you have an agreement in place which properly and carefully covers those matters.

It is easier to protect confidential information and prevent poaching of staff than to prevent competition or non-solicitation from former employees. However, employers can protect themselves by ensuring that:

  • the restraint applies specifically to the circumstances of the individual employee and his or her work; and
  • the employee is independently advised prior to his or her agreement to the restraint; and
  • in circumstances where compliance with the restraint is critical to the business of the employer, valuable consideration is given to the employee in exchange for the restraint.

For more information contact Leonie Kyriacou at l.kyriacou@pigott.com.au.

This article is intended to provide general information in summary form on a legal topic, current at the time of publication.  The contents do not constitute legal advice and should not be relied on as such. Formal legal advice should be sought in specific circumstances.