The cost of breaching a restraint of trade

The cost of breaching a restraint of trade

Many employees are under the impression that restraints of trade are “not worth the paper they are written on.” This blasé attitude towards restraints, which are a common feature in employment agreements, follows on from a history of these clauses being generally seen as unenforceable, due to their impingement on personal liberties and freedom of contract. A restraint of trade, or “restrictive covenant”, is a contractual provision that restricts an employee’s activities after their employment has ended. Restraints come in three forms, restricting an ex-employee’s ability to work for a competitor or to start business in competition, restricting them from poaching former clients or restricting them from headhunting other employees of their former employer. Many employees tend to ignore any restraint provisions at the conclusion of their employment, violating their terms and forcing their former employer to get a declaration that the restraint was lawful in order for it to be enforced.

Current Status

Ignoring a restraint of trade clause in your employment agreement can be risky. Employees going to work for competitors, or soliciting other employees and clients when they leave, is a long-standing issue. Restraints of trade can be an important tool in dealing with these situations and legitimately protecting an employer’s business. While many employees may opt to take their chances in violating a restraint, the penalties in recent cases may make them rethink this disregard for their contractual duties.

Recent case law shows a trend towards the Employment Relations Authority imposing significant awards of damages where an employee has blatantly breached their obligations towards their former employer. In Zeald New Zealand Ltd v Bernard, Bernard was ordered to pay his former employer $50,000 for multiple breaches of restraints of trade and other provisions in his employment agreement. Completing the trifecta of restraint of trade breaches, Bernard worked for a competitor and solicited three of Zeald’s employees and 41 of Zeald’s customers while he was still subject to restraint clauses covering all three actions. The ERA held the severity of this penalty was necessary to punish him for his flagrant conduct and deter other employees who may contemplate breaching their employment obligations.

Aon New Zealand v West held that a 12-month restraint of trade clause prohibiting the employee from soliciting customers from his former employer was reasonable and enforceable. West was the senior accounts manager for Aon, and it was found that, in this role, he had received significant and confidential information about Aon’s business and had opportunities to forge strong relationships with clients. Following the end of his employment, he had dealt with 18 former clients in breach of the restraint of trade in his employment agreement. This is another in a recent string of cases that seem to be taking restraints more seriously, and in this instance, West was ordered to pay over $70,000.

How is a restraint’s enforceability determined?

The common perception that restraints of trade are unenforceable is down to their status at common law as prima facie unlawful, unless they are proven to be reasonable. While this means that a large number of restraint provisions have been found to be void when challenged in the past, employers are now becoming more savvy as to what is required to make these clauses enforceable.

To be valid, the provision must be made to protect a legitimate proprietary interest, and it must be no wider than reasonable to protect that interest. Requiring a restraint of trade to protect an employer’s proprietary interest ensures that these clauses are not used just to discourage competition. The restraint should be focused on a role that uses specific information such as trade secrets, confidential information or special business connections. This information should be isolated from non-confidential information and not part of the individual’s personal skills, general knowledge or experience. The duration of the restraint is also assessed in considering reasonableness, but there is no set standard for all cases. The reasonableness of the duration depends on such things as the nature of the employee’s role, the “shelf life” of the information they deal with, the geographical scope of the restraint and the nature and extent of the employer’s business. Generally, a restraint will not be considered reasonable if it is longer than 12 months. A restraint should only be as wide as reasonably necessary considering these factors, and consideration must be given by the employer for it to be enforceable.

If a restraint of trade is found to be unreasonable, the Court or the ERA may modify it or find it to be simply unenforceable. While many employers often use restraints wrongly, casting them far too widely to cover positions that do not deal with specific proprietary information, this does not mean that employees should rely on being able to breach them in all circumstances.

Drafting is key

Problems with unenforceable restraint of trade clauses are usually caused by employers using template provisions in employment agreements that don’t consider the purpose, nature and extent of each restraint. When drafting a restraint, employers need to make it as individualised and as limited as possible in the circumstances. The best time to introduce a clear, detailed restraint is at the beginning of the employment, as consideration for the restraint can usually be the remuneration agreed to in the initial agreement.

Employees need to consider what they are being contractually obligated to when entering into an employment agreement that features a restraint of trade clause. The difficulty arises when a clause seems onerous and an employee is faced with the decision of either signing the agreement and assuming it will be unenforceable should they ever breach it or trying to negotiate a clause with their new employer at the outset, when it may end up being of no relevance to them in the future. While general attitudes of employees have tended to discount restraints of trade, the case law shows that this can have huge repercussions, especially when combined with breaching other continuing aspects of their employment agreement. At the end of the day, these provisions are legal, contractual obligations and should not be ignored … providing they are reasonable.

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