Restraining trade: proceed with caution

More often than not, an employment contract will contain some sort of clause restraining the employee from competing with the business of the employer once that employee leaves that employer.

The interpretation of these clauses is often put in front of the courts as parties address the inevitable tension between employers seeking to protect their business and employees eager to exploit their experience to the full once they have moved on from their original position.

Careful drafting of these clauses is paramount as the courts have very strict rules they apply when determining whether or not these restraints are valid. Often, an employer’s efforts to enforce restraints of trade by way of injunction are fruitless because adequate care was not taken in drafting the restraint in the first instance and the restraint is largely irrelevant to the particular contract, and sometimes to the particular business.

Injunctions are expensive and difficult to obtain at the best of times, and parties only make it more difficult for themselves if they do not ask the right questions at the very start and set themselves up with a valid and enforceable restraint.

Courts have very strict rules they apply when determining whether or not a restraint of trade is valid. In recent cases, notably Idameneo (No 123) Pty Ltd v Dr Teresa Angel-Honnibal [2002] NSWSC1214, the Supreme Court of NSW stated that the enforceability of a restraint of trade is dependent on:

(a) whether it is reasonable between the parties; and

(b) whether it is contrary to the public interest.

The onus of proof as to whether or not the restraint is reasonable between the parties rests with the applicant and the onus of proving that the restraint is not in the public interest would rest with the party seeking to invalidate the restraint.

In demonstrating that the restraint was not in the public interest, the defendant would need to show that the restraint is anti-competitive and flies in the face of principles of free trade and productive communities.

In proving that the restraint was reasonable, the employer would need to justify the restraint by reference to the circumstances of the particular case and that it has been drawn with reference to the professional activity involved.

Questions to ask when formulating a restraint of trade covenant may include:

1. What aspect of the business is being protected?

2. Is a geographic restraint relevant? If so, how expansive should it be in order to be considered reasonable?

3. Is protection of a particular client base relevant? What is the composition of that client base?

In Idameneo’s case, Idameneo Pty Limited purchased a medical practice. The doctor selling the medical practice was subsequently employed by the company and was subjected to two restraints:

(a) a restraint in the sale contract stating that she could not render medical services at any place within an 8km radius of Idameneo’s Burwood or Leichhardt medical centres; and

(b) a restraint in the contract of employment stating that for a period of five years, she was to work exclusively in the Leichhardt practice and would not render medical services within an 8km radius of the Leichhardt premises while the contract was in force.

The doctor left the Idameneo practice within one year of signing the contracts and commenced practice 1.5 km from the medical centre.

Idameneo sought an injunction claiming that there was a breach of the restraints in both the sale of practice contract and employment contract and claimed damages.

The court held that the restraints were unreasonable because Idameneo was unable to justify the restraint to the circumstances of its particular case for the following reasons:

(a) the restraint clauses were standard clauses (there was no evidence that they had been negotiated between the parties) and, in particular, Idameneo could not show that when drafting the restraints:

(i) the type of practice conducted had been taken into account, for example, a restraint for a doctor in a general medical practice would be different from a restraint over a person specialising in neurosurgery; and

(ii) the characteristics of the locality in which the practice was located had been taken into account (for example, a restraint prohibiting practice within a 20km radius may be reasonable in a country town, but unreasonable in the Sydney centre);

(b) the restraint boundaries were not clear and there was no evidence presented by a map or otherwise in respect of the restraints in question, and in addition, there was no evidence as to the justification of the area restrained through demographic evidence or evidence of the number of doctors practising in that area;

(c) Idameneo could not show that the majority of patients in the practice had lived within an area of 10km from the relevant medical centre.

The court held that Idameneo was not entitled to an injunction as stated in the agreements but was entitled to an injunction preventing the defendant from practising at the particular site involved. This was a result of the operation of the Restraints of Trade Act 1976. If the court holds that the restraint is not enforceable, the specific situation may be validated under the Restraints of Trade Act 1976 (NSW), which states that where a restraint of trade is against public policy (and therefore unenforceable) because of a failure by the person who created it to make it reasonable, the Supreme Court of New South Wales is free to read down the restraint in such a way as to make it reasonable and therefore enforceable. This means that the Court has the discretion to alter a restraint and make such amendment binding on the parties.

In Idameneo’s case, the Court read down the restraint to make it a ‘brass plate restraint’, meaning that the defendant was not prohibited from medical practice in the area (that is, her patients could reside in the designated area), but was prohibited from establishing a surgery in the relevant area.

The defendant in the case claimed that the restraint was ‘contrary to the public interest’. It claimed that the restraint went beyond any legitimate protection that Idameneo was entitled to claim and that it interfered with patients’ individual liberty and right to choose their own doctor.

Because Idameneo could not prove that the restraint was no greater than necessarily needed to protect its legitimate business interests, the defendant was successful in her defence.

If the right amount of care, time and effort had been taken in setting the terms of the restraint in the first place and consideration had been given to all the vital elements of the business relevant to the restraint, Idameneo would not have experienced those difficulties.

Peter Townsend is the principal lawyer of Peter Townsend Lawyers & Business Advisers.