When a company parts ways with their employees, it is typical for the employment contract to contain clauses which restrain the employee from participating in competitive activities in particular territories for a period of time. These contractual restraints are commonly drafted so they ‘cascade’, which is intended to provide a framework to prevent overreaching restraints from being found to be unenforceable. In this article, we look at the enforceability of restraint clauses, and some key things to be aware of in drafting them.
A competition restraint in an employment contract seeks to limit the activities of a person once they cease to be employed. For example, it might provide that upon termination of employment the person cannot be employed by their former employer’s competitors for a period of time.
Typically in Australia, such a clause is drafted with the prohibitions expressed in the alternative. For example, the person is restrained for a Restraint Period in a Restraint Territory as follows:
Restraint Period means:
Restraint Territory means:
Restraint clauses were first notably litigated in Herbert Morris Ltd v Saxelby [1916] AC 688. Saxelby, a specialised engineer, was under a restriction that prevented him from working directly or indirectly in any similar businesses for seven years. Ultimately, the court determined that this restriction went far beyond protecting the employer’s business, and instead stopped the employee using his skills and experience. In finding the restraint to be against the public interest, Lord Shaw stated at [718]:
“it is, justly interpreted, a claim to put him in such bondage as regard to his own labour that he must, for seven years of his life, become an exile”.
The common law principle evolved so that it was in the public interest for someone to be free to earn a living, and that the employer’s legitimate interest in restraining that freedom should be confined to protecting its trade secrets and customers. Today, to be enforceable the general test is that the restraint must:
To accommodate the uncertainty of what constitutes a reasonable restraint, the legal practice has evolved in Australia (and other common law jurisdictions including England) to include cascading restraints in an employment agreement. The idea is that, if a higher degree of restraint may be considered too severe, the court can enforce a lesser restraint without the entire clause being void.
It is common for cascading restraints to impose restrictions across different facets, such as activities, geographical areas, time periods and competing businesses.
Cascading clauses may set out an ambit claim by the employer. Particularly where the employee has acquired valuable knowledge in the course of their employment, the employer is often motivated to try and make the period of restraint as long as possible. The longer period will stand unless a Court intervenes or the parties settle as part of a future negotiation.
In the example above, the Restraint Period may be amended by the Court with a ‘blue pencil’ as follows:
Care should be taken in drafting restraints with too many levels of cascades or permutations, as it may be void for uncertainty. In Austra Tanks Pty Ltd v Running (1983) 40 ATPR 340, the Court drew the line at 82,152 restraint combinations, holding that the restrictions were unenforceable due to uncertainty.
The question though is what is genuinely required in the circumstances. In Bulk Frozen Foods Pty Ltd v Excell [2014] TASSC 58, the Court found that 8,019 possible restraint combinations was permissible.
In Just Group Limited v Nicole Peck [2016] VSCA 334 (Just Group Case), a list of 50 blacklisted competitor entities was attached to the employment contract. In that case, the Court refused to sever the list and enforced only one restraint (against the largest competitor of Just Group) on the basis that severing individual entities from the annexure would require rewriting the provision, which was beyond the Court’s power.
In all States and Territories of Australia except New South Wales, there is no power to ‘read down’ a clause. Though there is no bright-line definition of the term ‘read down’, it is generally accepted to refer to the ability of the Court to amend a contractual provision rather than just strike through the clause with a ‘blue pencil’. In the context of an employment restraint, it enables the Judge to narrow the scope of the provision to the extent it deems reasonably necessary to give the employer the benefit of partial enforcement. This does not extend to redrafting the structure of the clause, but amending the restraint, for example the time period, to be consistent with public policy and what the Court regards as reasonable in the circumstances. This is as opposed to just striking through a pre-prepared list.
Section 4(1) of the Restraints of Trade Act 1976 (NSW) (Act) provides the NSW Supreme Court the power to ‘read down’ restraint clauses to give effect to the restraint. This power can only be exercised if the Supreme Court concludes that the clause is inconsistent with public policy but can be read down to become consistent.
In Industrial Rollformers Pty Ltd & Anor v Ingersoll-Rand (Australia) Ltd [2001] NSWCA 111, it was held by the Court of Appeal that Bergin J was within their discretion to ‘read down’ a restraint clause to reduce the period of non-competition from 5 years to 9 months, and restrain the territory from worldwide to Australia[1].
Giles JA noted at [191] that the initial provision ‘…was too wide, but the more limited protection at which Bergain J arrived, sufficient to neutralise the first appellant’s springboard advantage, is in my view reasonable between the parties and has not been shown to be unreasonable in the public interest.’
Despite the above judgment, the application of s 4(1) has resulted in some confusing judicial reasoning. In Woolworths Limited V Mark Konrad Olson [2004] NSWCA 372, Mason P providing the following commentary (bold added):
‘Section 4(1) allows the court to ignore the fact that the restraint goes beyond what is reasonable, provided the restraint can be enforced to an extent that is reasonable.’
Exactly what this means has been the point of some controversy over the years.
In Orton v Melman [1981] 1 NSWLR 583, McLelland J held at [61]:
‘first, the court determines whether the alleged breach (independently of public policy considerations) does or will infringe the terms of the restraint properly construed. Next, the court determines whether the restraint, so far as it applies to that breach, is contrary to public policy. If it is not, the restraint is valid, subject to any order which may be made under s 4(3).’
In Seven Network (Operations) Limited & Ors v James Warburton (No 2) [2011] NSWSC 386, Pembroke J observed (bold added):
‘I will nonetheless observe that the language of Section 4(1) is enigmatic in its brevity and the explanation in Orton v Melman [1981] 1 NSWLR 583 (McLelland J) is neither entirely clear nor, pending an appellate decision, necessarily the last word on the subject. However, there are at least suggestions… that Section 4(1) may be utilised in circumstances such as these to read down a restraint to the extent that it is excessive in its application to the circumstances of the particular breach.’
In Hanna v OAMPS Insurance Brokers Ltd [2010] NSWCA 267, where 27 possible restraint combinations were held to acceptable, the NSW Court of Appeal confirmed that cascading clauses are valid and enforceable. The decision determined that ultimately the Court will need to ask, “what is reasonably necessary to protect your business’ interests?”
Largely due to judicial uncertainty, the use of cascading restraints in New South Wales is still commonplace.
In Australian employment contracts, it is still best practice to draft restraints so that they cascade. This is true even in New South Wales, where the NSW Supreme Court has legislative power to ‘read down’ restraint clauses to give effect to the restraint. However, it is important restraints are carefully drafted to ensure that they are not deemed to be void for uncertainty, otherwise, an employer may entirely lose control over their employee’s competitive activities after their employment ends.
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[1] Amended from: ‘During the term of this Agreement and for five (5) years following its termination, except as authorized by Buyer, Seller shall not make a mining roof support which is similar in design to the mining roof support covered by this Agreement’, to instead read: ‘During the term of this Agreement and for a period of nine months from the date of the termination of the Agreement the Defendants shall not, within Australia, make a mining roof support similar in design to the mining roof support covered by this Agreement.’
