A non-compete clause is a clause in an employment contract that seeks to prevent employees from starting a business that competes with their employer. A non-compete clause is also known as a restraint of trade clause. They can apply to a specific time period, location and industry.
Employers may not have a clear understanding of how non-compete clauses work and their implications. Often, non-compete clauses are confusing, vague and do not provide the legal protection the employer is looking for.
Ineffective non-compete clauses are not enforceable and are not worth the paper they are written on.
This article explains everything about a non-compete clause that employers should be aware of.
Author: Farrah Motley, Legal Principal of Prosper Law and a workplace lawyer.
What is a non-compete clause?
An employment contract may contain a non-compete clause that will take effect during the employment period and after an employee leaves the company.
The purpose of a non-compete is to restrict an employee from using the employer’s confidential information, intellectual property, and trade secrets to compete with the company. Although the explicit use of the information may be protected through confidentiality clauses and intellectual property clauses, a non-compete clause goes a step further.
Employees may not need to use stolen information to start a competing business. Over their employment period, employees are likely to have gained valuable knowledge and skills that are remembered and learned by the employee. A non-compete clause ensures that an employee cannot use this acquired knowledge to the detriment of their employer (subject to the limitations discussed in this article).
A non-compete clause can protect your company from having current and former employees compete with your company. Therefore, a non-compete clause in a contract is essential to protect an employer’s legitimate business interests.
This clause is a means by which you can do the following:
Prevent employees from stealing your clients
A non-compete clause can assist in deterring employees (or ex-employees) from stealing your clients.
However, your clients may choose to purchase goods or services from your former employee, provided they have not been enticed to do so.
Prevent employees from hiring your staff
A non-compete clause can prevent your former employees from soliciting your current employees. A properly drafted non-compete clause will ensure you have legal rights against your former employees if they solicit existing employees to leave their current employment and accept a position with the competing business. However, if it is not appropriately worded or an employment agreement does not contain a non-compete clause, employers may be putting the competitiveness of their business at risk.
Why is it important to include a non-compete clause in employment contracts?
Non-compete clauses protect employers by preventing workers who have acquired knowledge or trade secrets from using corporate technical and intellectual property to compete with their former employers.
If an employment contract does not contain a legally enforceable non-compete clause, employees are legally entitled to start a competing business. There are no restrictions on the industry or location of the competing business. This can be particularly problematic for businesses that are heavily reliant on customer traffic from a particular location or where there is limited demand.
A non-compete clause may have a deterrent effect; by including it in an employment contract, employees are put on notice that they will be breaching the contract if they start a competing business.
A non-compete clause cannot itself prevent an employee from breaching their employment contract, but it does provide an employer with legally enforceable rights against the employee.
How should a non-compete clause be written?
Before attempting to include a non-compete clause in your company's employment agreement, you must understand the legal aspects of restricting the income-earning activities of an employee.
Just because an employment contract contains a non-compete clause, it does not necessarily mean that the clause is legally enforceable.
The non-compete clause must be specific, but not too restrictive or harsh. If the clause goes beyond what is necessary to protect the employer’s legitimate business interests, it can be invalidated for being too restrictive.
It is therefore advisable to obtain legal advice from an employment law firm to write a non-compete clause.
In order to draft an appropriate non-compete clause, your employment lawyer may need to understand the following:
what activities do you want to prohibit the party from performing?
what time period would you like to prohibit the party from engaging in the activity?
do you want to prevent the party from doing business worldwide or in a specific geographic area?
are the geographic areas appropriate to protect your interest?
what is the interest you are trying to protect?
There are no defined rules or fixed parameters to decide the extent to which a non-compete clause in an employment contract may be enforced.
Rather, each case depends on its own facts and circumstances and the wording of the particular clause. However, when drafting a non-compete clause for employment contracts, you can consider the following things:
A non-compete clause needs to be reasonable
Only reasonable non-compete clauses are legally enforceable. Thus, they should be no more restrictive than is necessary to protect the employer's legitimate business. As for the meaning of the term ‘reasonable’, we have a detailed article about the reasonable person test.
In summary, what is ‘reasonable’ depends on what a reasonable person of common sense and knowledge would consider reasonable under the circumstances. Therefore, the test depends on the facts and circumstances of each case. Whether or not an agreement containing a non-compete clause is valid and appropriate is ultimately decided by the courts and depends on the facts of each case.
Should have a sliding scale for the area covered by the restraint
You may find it necessary to include a geographic restriction in the non-compete clause. A geographic restriction means that the employee may not compete with you in a particular area or solicit customers who do business with you.
However, the geographic region in which competition is restricted must be clearly defined. A non-compete clause is not enforceable in an unreasonably large territory.
As a general rule, the larger the area covered by the clause, the more difficult it is to enforce. Narrow and specific geographic restrictions may be more likely to be legally enforceable.
Whether or not a geographic restriction in a non-compete agreement is considered reasonable depends on the specific circumstances of the situation, such as what the company does and the industry it operates in, where its potential customers are located and how the clause would impact the employee’s ability to earn an income.
Although this is undoubtedly considered, there is no rule defining an appropriate geographic limitation in kilometres or boundaries. In general, however, a geographic restriction is likely to be considered reasonable if it:
is necessary to protect the employer's business, such as protecting its customer relationships, but is not intended to protect the employer from any potential competition where it does (or could do) business; and
does not seriously prevent the former employee from earning a living in their profession.
Courts are more likely to enforce narrow and specific geographic restrictions than broad ones. However, courts may enforce broad geographic restrictions in non-compete agreements with senior employees. This is particularly true if the company can demonstrate that:
the broad geographic restrictions are necessary to protect the company's highly confidential information; and
the other restrictions in the non-compete clause are narrowly drawn (including a specific list of customers with whom the executive may not contact; competitors for whom the executive may not work; or products or services with which the executive may not work in a subsequent job).
It is therefore advisable to obtain legal advice from an employment law firm to write a non-compete clause.
Should have a sliding scale for the length of time the restraint applies
A non-compete clause cannot last forever, so an employer must include a reasonable time limit in the agreement. It would be unreasonable for an employer to expect a former employee to comply with the non-compete rules indefinitely. Because of this, a non-compete that has no end date will be unenforceable.
The general rule is that the duration of the agreement should not exceed the period reasonably necessary to protect the employer's legitimate business interests. However, what is considered ‘reasonable’ varies from business to business and requires specific consideration of the facts and circumstances of the non-compete.
A reasonable period of time for a non-compete clause can range from 1 month to 12 months, and the period of time the employer chooses will depend on the nature of the work and the industry.
For example, a court will likely refuse to enforce an agreement that prohibits an employee from competing for 2 years after their employment ends.
The non-compete clause should clearly outline what activities it applies to
A non-compete clause must specify the ‘competitive activities’ that the employee may not engage in after termination of employment. A clear definition of ‘competitive activities’ is helpful in understanding what is prohibited.
For example, competitive activity may consist of accepting employment with a competitor or serving on the governing bodies of a company with a similar profile and developing its own business targeting the same group of customers.
For example, if someone works as a sales representative for an engineering firm, the activities related to his or her sales activities should be specified in the non-compete agreement. However, if that person decides to work for another company in human resources or operations, the information they received while working in sales is unlikely to be helpful or relevant in their new role.
However, a blanket non-compete that is not specific to any industry would prevent the employee from accepting the new HR or operational position. Such a restriction would not be enforceable. A workplace lawyer will be able to provide legal advice to ensure such clauses are enforceable.
When will a non-compete clause not be legally enforceable?
You may use non-compete clauses to protect your business interests after an employee leaves your company. However, remember that non-compete clauses are considered void and unenforceable unless you can show that they are necessary to protect your legitimate business interests.
It is up to you to prove that the clause is not unreasonably broad or it will not be enforceable. An employment lawyer will be able to advise on the enforceability and wording of a non-compete clause.
When drafting a non-compete clause, you must therefore bear in mind that a non-compete clause is considered unenforceable in circumstances where:
There is no legitimate business interest to protect
Employers may not impose unreasonable restrictions that unreasonably limit an employee's ability to earn a living. If an employer wishes to restrict an employee, they must have a legitimate business interest that they want to protect. Legitimate interests generally include business interests or goodwill (intangible assets such as reputation, customer relationships, and proprietary technology).
In Australia, courts consider non-compete clauses reasonable only if they are necessary to protect the legitimate business interests of the party benefitting from the clause. A workplace lawyer will be able to advise on the current legal understanding of non-compete clauses.
There have been situations in which the courts have recognised that an employer has a legitimate interest in imposing a non-compete:
when an employee has access to confidential information and may use it to the detriment of his or her former employer;
if an employee has contact with the employer's customers in the course of his or her work and could use those connections to solicit customers; and
when an employee is in a position to solicit colleagues from his or her former employer.
In each of the above situations, the courts have recognised a legitimate interest that is reasonable to protect.
The employee's former position is usually an important factor in determining whether any of the above situations apply to his or her situation. For example, a restriction may be more appropriate if it is placed on senior employees who have access to trade secrets or direct contact with customers.
Where the clause is not reasonable
You cannot use a non-compete clause to protect your business from the normal competitive processes in an industry or market.
If you try to enforce an unreasonable non-compete clause, it may be contrary to public policy and the principles of a market economy. This is because such a clause may prevent a party from participating in business.
For example, a clause may be unreasonable if it prevents a party from offering its skills or engaging in further business activities. In other words, the clause should not be too broad and should not prevent anyone from making a living.
Courts are able to set aside a non-compete clause if they deem it unreasonable. However, a non-compete clause is more likely to be upheld if it contains a series of overlapping restrictions, known as step clauses or cascading clauses. These clauses often lead the court to accept the least broad scope of the restriction.
Thus, the court has a range of options to choose from. Therefore, a modified version of the clause may be enforceable after the court has decided which combination of cascading criteria are appropriate.
Case law examples of non-compete clauses
You need to know precisely what is fair and legal when including non-compete clauses in employment agreements. The easiest way to do this is to engage a workplace lawyer.
The following cases illustrate the approach of the Australian courts in deciding whether to enforce non-compete clauses in employment agreements:
Austal Ships v Clay [2018] WASC 178
The Supreme Court of Western Australia granted an interlocutory injunction in favour of an employer that prevented a former assistant project manager from moving to a competitor while the court determined whether or not the restriction was reasonable.
In ordering the injunction, the court noted that the new employer was a direct competitor against whom the former employer had just lost a bidding process. The employee had current knowledge of confidential operations at his former employer and confidential information about current tenders. As a result, there was a real risk that the employee might reveal confidential information and harm the employer's interests.
SAI Global Property Division Pty Ltd v Jones [2018] NSWSC 438
The New South Wales Supreme Court refused to grant an interlocutory injunction against a former head of segment and strategic sales because there was no evidence that the employee had taken confidential information with him when he left.
Upon reviewing the record, the court found that enforcing the prohibition wasn't justified since the employee didn't move directly to a competitor, but to a subsidiary.
Dargan Financial Pty Ltd ATF the Dargan Financial Discretionary Trust (trading as Home Loan Experts) v Nassif Isaac [2017] NSWSC 1077
The Supreme Court of New South Wales examined whether an employee breached his post-termination obligations when he disclosed customer information to his new employer.
The employee tried to argue that the customer information was easily accessible on Facebook and did not constitute confidential information of the employer. According to the court, customer data contained more details than just the individuals' contact information and included financial information. As a result, the court ordered an injunction in favour of the former employer and a claim for damages.
Buckley v Tutty (1971) 125 CLR 353 at 380
A non-compete clause will not be taken at face value. The court will only uphold it if it's reasonable. For example, a court will not enforce a clause that unfairly restricts an employee's right to contribute his or her own labour.
The High Court of Australia stated:
“Unreasonable restraints are unenforceable as it is contrary to the public welfare that a person should be unreasonably prevented from earning a living in whichever lawful way he chooses and that the public should be unlawfully deprived of his services."
The employee (Ms Tokody) moved to a direct competitor in the travel insurance industry. She was one of the most senior employees of AGA.
In her role, she had direct contact with key clients with long contracts of up to three years and was privy to important confidential information. In addition, she had signed a contract that contained several non-compete clauses. This prohibited her from being employed by a direct competitor in the travel insurance industry.
The court found that 12 months was a reasonable period of time to protect her employer.
The court also noted that this may affect any compensation claim if it can be shown that the employer failed to adequately protect its relationships after the employee left.
Freshfood Management Services Pty Ltd
A senior employee of Freshfood Management Services Pty Ltd resigned with two months' notice. He wanted to move to Cantarrella Bros, a direct competitor in the new coffee industry. As a senior executive, the employee had confidential information, including sales and management information.
The employee sought a judgement to avoid the non-compete clause in his contract that prevented him from accepting employment with a competitor in NSW 12 months after termination, under Section 106 of the Industrial Relations Act 1996.
The judge found that Freshfood had to demonstrate the reasonableness of the non-compete clause. The general rule was that non-compete clauses are void at common law because they are contrary to public policy and are only permissible if special circumstances make the restriction 'reasonable'. The judge found that the 12-month restriction was unreasonable because:
it was contrary to the public interest to deprive the community of the employee's services;
it would impose a heavy financial burden on the employee without good cause; and
there was no threat to Freshfood over an extended period.
He also noted that the restriction applied only to NSW, but the employee wished to remain in Sydney, which was not unreasonable. However, the remainder of the non-compete clause was found to be fair, as a reasonable restriction was six months from the date the employee resigned and no longer had access to Freshfood's sales, management, blending or technical process information.
How can Prosper Law help?
Prosper Law is an employment law firm with experience providing employment law services to employees and employers. If you have questions about the enforceability of a non-compete clause or you need a clause to be drafted into an employment agreement, contact our team today and speak with an employment lawyer.
Farrah Motley | Legal Principal
PROSPER LAW - A Commercial Law Firm for Businesses
M: 0422 721 121
A: Suite No. 99, Level 54, 111 Eagle Street, Brisbane, Queensland Australia 4000
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