Restraints of trade - Cautionary tales for former and future employers

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25 July 2013

Employers are increasingly relying on restraint of trade clauses to protect their businesses when former employees begin working for a competitor. Some recent restraint cases serve as cautionary tales to employers and employees about the operation and enforceability of restraint provisions, and the preparedness of the Courts in New South Wales to enforce restraints.

RESTRAINTS – A QUICK REFRESHER

Restraints of trade are included in employment contracts to protect an employer’s trade secrets, confidential information, customer connections and staff connections by restricting an employee’s activities after they have left employment. Restraint of trade clauses will be enforceable to the extent that the restraint is reasonably necessary to protect the legitimate business interests of the employer. Whether a clause is reasonably necessary will turn on the particular clause and facts of the case.

The common remedy sought by employers faced with an employee’s breach of a restraint clause is to seek an injunction to restrain an employee or former employee from acting in a way, or continuing to act in a way, that breaches a term of the former employment contract. For example, an injunction may prevent a former employee from working for a competitor for a certain period of time or from using or disclosing information confidential to the former employer and its business.

When exercising its discretion to grant an injunction, the task for the Court, even before determining whether a breach has occurred, is to determine whether the restraint clause is enforceable.

Accordingly, having an enforceable and valid restraint in employment contracts is crucial if an employer hopes to rely on it to enforce a former employee’s post-employment obligations. This issue needs to be considered by employers when the employment contract is drafted because a court will consider the reasonableness of the restraint as at the time the contract was entered. 

Some pointers for drafting restraint clauses in employment contracts:

  • make sure the period of restraint is commensurate with the employee’s position and access to confidential information;
  • make sure the prohibited activities prevented are similar to the employee’s current activities; and
  • ensure contracts are reviewed regularly and updated to reflect changes in role.

REPUDIATION OF CONTRACT – FISHLOCK V THE CAMPAIGN PALACE PTY LIMITED [2013] NSWSC 531

A further factor that needs to be considered to ensure the enforceability of a restraint provision, is the validity of the employment contract containing the restraint. A restraint of trade provision, no matter how well-drafted and reasonable, will only be enforceable if the employment contract that contains the provision still governs the relationship between the employer and former employee at the time the employment was terminated.

For example, if a former employee can show that his or her duties were substantially changed by the employer without obtaining the employee’s agreement, a Court may find that the employer repudiated the contract and its provisions became inoperative.

In the case of Fishlock v The Campaign Palace Pty Limited [2013] NSWSC 531, the New South Wales Supreme Court found advertising agency, The Campaign Palace, was unable to enforce its otherwise valid restraint provision against Mr Fishlock, a former executive creative director, because The Campaign Palace had repudiated the contract that contained the restraint provision. The case is considered below.

Facts

Mr Fishlock was appointed Executive Creative Director of the Campaign Palace in 2003. In this role, Mr Fishlock had ultimate creative responsibility for the agency’s offices in Sydney and Melbourne, as well as for the supervision of the creative output of the creative directors and other staff. In 2011, Mr Fishlock was advised (by email) of a significant decrease in his responsibilities and status in the agency with the effect that he would no longer have creative responsibility for the Sydney and Melbourne offices.

Mr Fishlock brought a claim in the New South Wales Supreme Court, seeking damages on the basis that his employment contract had been repudiated and a number of declarations, including that the restraint provision in his contract was not operative.

Outcome

The Court found that The Campaign Palace’s treatment of Mr Fishlock amounted to a repudiation of the contract, and awarded Mr Fishlock damages in the sum of $268,259. The Court went on to consider the restraint provision, which would have restrained Mr Fishlock from soliciting clients or employees of The Campaign Palace and conducting business of a similar type for one year after his employment ended. The Court found that, in light of Mr Fishlock’s seniority in the agency and the nature of the business, such a restraint would have been reasonable in the circumstances. However, because the Court had already found that The Campaign Palace had repudiated the contract, the agency was not entitled to the benefit of the restraint clause.

NEW EMPLOYER ON THE HOOK FOR COSTS – HRX PTY LTD V SCOTT [2013]

The NSW Supreme Court has taken the rare step of imposing costs on a company that, even though it was not a party to the litigation, funded an employee's defence of a restraint case instigated by his former employer.  This involved a novel use of its powers under section 98 of the Civil Procedure Act 2005 (NSW) to determine who pays the costs of any proceedings, in HRX Pty Ltd v Scott [2013].

Facts

Mr Scott was employed by HRX, a recruitment agency, in a senior managerial position. His employment contract contained post-employment restraints prohibiting him from soliciting HRX's clients and from working in a competitor's business for 12 months after the termination of his employment with HRX. Mr Scott resigned from HR and commenced employment with Talent2, a direct competitor of HRX.

HRX commenced proceedings against Mr Scott in the Supreme Court for breach of the restraint in his contract with HRX.

Talent2 initially funded Mr Scott’s defence of the litigation brought against him by HRX, however, once it became apparent he was in breach of his post-employment obligations to HRX, they withdrew their funding.

Outcome

In deciding to award costs against Talent2, Chief Justice Bergin found that Talent2 was the active party behind Mr Scott’s defence of the proceedings. She cautioned that the power to award costs against a non-party to proceedings "should be exercised sparingly", but she was satisfied it was appropriate in this case.  This was because “but for the funding by Talent2, the litigation would not have been necessary” since Mr Scott could not afford to run the case. Moreover, Talent2 had a substantial interest in the litigation and knew “the benefits that would flow to it” if it were successfully defended.

Key points

  • Employers should be wary of becoming too involved in any dispute between a new employee and their former employer arising from an alleged breach of restraint.  Extensive involvement or support offered to the new employee could result in a costs order against the new employer whether they are a party to court proceedings or not.

Both of these issues were considered by Corrs in a recent restraint matter.

poaching for a start up - custom house v connors

Corrs recently acted for Custom House, a subsidiary of Western Union Business Solutions, in a restraint matter against Tim Connors, a former senior employee who was in breach of the restraint and confidentiality clauses in his employment contract. Mr Connors was recruited by an international competitor of Western Union, Cambridge Mercantile Group, to start up the Australian operations for Cambridge earlier this year.

Custom House, the employer, commenced proceedings against Mr Connors to enforce his contractual post-employment obligations regarding Mr Connors’ use of confidential information, which it alleged he had sent to a personal email address and saved on a USB drive before his employment was terminated.

In April 2013, Custom House sought an urgent injunction from the Supreme Court to prevent the former employee working for Cambridge and to return any confidential information he possessed. Justice Stevenson made orders (by consent) on an interlocutory basis that Mr Connors could not perform any work for the competitor until the end of the restraint period of six months, and that all confidential Custom House information be returned and destroyed. The Court also appointed an independent forensic analyst, Ferrier Hodgson, to conduct an investigation of certain electronic devices belonging to Mr Connors.

The proceedings were resolved by Mr Connors providing to the Court undertakings on substantially the same terms as the interlocutory orders made by Justice Stevenson and Mr Connors is also required to pay a contribution to Custom House’s legal costs. The undertakings were formally noted in consent orders filed with the Court.

Key points

  • If you suspect that an employee is taking or has taken confidential information in breach of their contractual obligations, conduct an internal investigation of the employee’s email and other IT systems.
  • If there is evidence to suggest that a former employee has taken confidential information for use with a competitor, consider involving a forensic computer expert to search the devices the employee used and determine the extent of any breaches.
  • Think twice about knowingly employing a person who may be in breach of post-employment obligations with their former employer.

The content of this publication is for reference purposes only. It is current at the date of publication. This content does not constitute legal advice and should not be relied upon as such. Legal advice about your specific circumstances should always be obtained before taking any action based on this publication.


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