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Contract Drafting Tips Series: Restraint of Trade Clause

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A restraint of trade clause seeks to restrict the freedom of a person to trade or deal in specified ways with assets, information or third parties. It can apply during a contractual relationship and also for a period after its termination or expiry.

This article is part of our series on drafting tips for contract clauses.

The law is that a restraint of trade is contrary to public policy and unenforceable unless the restraint is reasonable in the parties' interests and also in the public interest: Attwood v Lamont (1920) 3 KB 371.

The typical situation we see is when a company, employer or employee calls us in a panic for advice on a restraint. It's best to check restraints earlier than this.

If a verbal or written restraint is unreasonable then it is unenforceable. Its validity should be assessed at the time it is imposed. For written agreements that's usually when it is signed. This is the honeymoon period, usually the panic attack arises years later when the relationship has ended or is breaking down.

The legal onus of proof is on the party seeking to enforce the restraint to prove that the restraint is reasonable: Lindner v Murdock's Garage (1950) 83 CLR 628 at 646. The onus is on the party challenging the restraint to prove that it is against the public interest.

The law of restraint of trade can be used effectively for only protectable interests.

  • In an employment agreement situation a broad contractual restraint of trade restriction against all types of future competition by the former employee is unenforceable. A court  would have little hesitation in striking the restriction out and freeing the employee to compete. The restriction would not be a protectable interest.
  • Courts tend to be more critical of restraints on employees than in many other situations. This is especially if a company adds a new or additional restraint to an existing employee.
  • The law which applies to restraints of trade in sale of business transactions permits the prohibition of behaviour by the seller which derogates from the goodwill the seller sold to the buyer. This is an example of a protectable interest.

Legislation

Restraint of Trade Act 1976 (NSW). This act seeks to overcome difficulties in the common law.

Contracts Review Act 1980 (NSW).

Cases

  • In Wentworth Partners Estate Agents Pty Ltd trading as RE MAX Gold v Gordony [2007] NSWSC 1135, the Court considered whether the defendant, a former employee of the plaintiff real estate agency, should be prevented from making use of a rent roll that the defendant agent had emailed to his private email address after having resigned. There was both a restraint of trade clause and a confidentiality clause in the employment contract. The court ruled the restraint of trade clause was too wide and hence invalid. It was a bald block against competition. The confidentiality clause, however, was held to be valid and hence the former employee was bound to not use the rent roll.
  • Buckanara v Hawthorn Football Club Pty Ltd (1988): A restraint of trade covenant is prima facie void.
  • Orton v Melman (1981) 1 NSWLR 533: There are public policy elements involved in determining if a restraint of trade covenant is valid. The court will consider the equality of the bargaining power between the parties, the length and scope of the clause, and the type of prohibition involved in the restraint of trade clause.
  • A restraint of 9 to 12 months was considered sufficient in IRAF Pty Limited v Graham (1982) 1 NSWLR 419 which related to a ladies hairdressing salon in Sydney CBD.
  • In Hawkesbury Bakery Pty Limited v Moses (1965) NSWR 1242 a bakery was sold and the restraint of 15 miles failed.
  • A restraint of three miles was held to be too wide in connection with a mixed business [Mertel v Rigney (1939) 56 WN (NSW) 122] and a hairdresser [Papastravou v Gavan (1968) 2 NSWR 286].
  • In some professions customers may be inclined to travel long distances to receive personal services. This is illustrated in Smith v Ryngil (1988) 1 Qd R 179 which involved an accountant and a restraint of three years and 15 miles. In that case one restraint was struck down because it was not limited to existing customers.

Drafting Tips

  • Given the law's strict attitude to restraints, apply great care to ensure clarity.
  • It is common for courts to treat poorly drafted restraint clauses to be void because they are uncertain. Alternatively in some cases a court can read down affected clauses (ie to reduce their breadth to something that is reasonable. Where appropriate use cascading clauses (as regards activity, geographic and duration restraints), but recognise that the interpretation of cascading clauses is often problematic.
  • While additional considerations are relevant in particular types of contracts (eg sale of business, employment or sale of goods), as a broad and useful overview, drafting a good restraint of trade clause involves considering four basic elements:
    • entity restrained;
    • activity restrained;
    • geographic extent of the restraint; and
    • duration of the restraint.

Sample Clause

32.1 For a period of one year after the termination of his engagement as a salesman, the salesman will not operate as an Agent or Sub-Agent within one mile of any main office or branch office conducted by the Agent at such date of termination.

This clause was the subject of debate in Phillip M Levy Pty Ltd v Christopoulos (1973) VR 673. A real estate agent, after leaving the plaintiff's real estate agency, obtained employment within one mile. The plaintiff filed for an injunction. Whilst the court recognised the plaintiff was entitled to protect its business, it could not establish evidence that it had goodwill within the one mile radius. The court did not enforce the above clause.

The takeaway lesson is - a restraint of trade clause must involve a clear and reasonable protectable interest.


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