Non-compete clauses and other restraints of trade in the spotlight pending ACCC review

Restraints of trade have recently been in the spotlight with the Australian Competition and Consumer Commission (ACCC) undertaking a review of non-compete and non-solicitation clauses in employment contracts. The review aims to assess the impact and use of these types of clauses on competition and to inform the Australian Government on whether any reforms are required.

As we await the results of the review, which is due to conclude in 2025, below we examine restraints of trade, their application, and how they are considered by the courts.

What is a restraint of trade?

A "restraint of trade" is an overarching term for a clause in an employment contract designed to:

• protect businesses from unfair competition, and
• prevent employees from using any confidential information obtained during their employment for the benefit of a direct competitor.

Restraints of trade can also arise in other contexts, particularly in the sale of a business. There are three restraints of trade clauses commonly found in contracts:

1. Non-compete clauses: prevent employees from joining a competitor for a set period of time.
2. Non-solicitation clauses: prevent employees from contacting or trying to get a client/customer or employee of the employer from moving to a competitor for a set period of time.
3. Non-disclosure clauses: prevent employees from using or releasing the confidential information of their former employer for the benefit of a competitor.

It is important to note that employers are not allowed to use restraint of trade clauses merely to protect from competition. This is why there is a test of reasonableness applied to any restraint of trade clause when the courts consider enforcement.

In Australia there are two different methods for determining whether a restraint is reasonable:

1. The common law position: restraints of trade are invalid and unenforceable for public policy reasons unless they protect an employer's "legitimate business interests".
2. The position in NSW: under the Restraints of Trade Act 1976 (NSW) (Restraints of Trade Act) restraints of trade are valid unless they are against public policy.

What is classified as a "legitimate business interest" is assessed at the date of entry into the restraint (i.e. when an employee signs their contract) and takes into account the surrounding circumstances of the business and individual.

Two recent cases demonstrate the application of the above.

AEI Insurance v Martin

AEI Insurance Group Pty Ltd is an insurance broker with a focus on heavy vehicle insurance. Mr Craig Martin was employed with AEI from 26 July 2011 until 2 September 2022.

Mr Martin’s primary duty was assisting AEI with new business growth opportunities. Mr Martin's mobile phone (which was the property of AEI) was AEI's 24/7 emergency accident assistance number. Mr Martin was considered the face of AEI's business in the Queensland market.

Clause 12 of Mr Martin's contract of employment was a restraint that lasted 12 months and prevented him from soliciting, canvassing, dealing, approaching or accepting an approach from any clients of AEI. Mr Martin resigned on 29 August 2022. On 31 August 2022, he informed AEI that he was moving to MA Brokers, a company in direct competition. At this point, AEI diverted the emergency assistance number to another AEI employee and Mr Martin purchased a new number. On 1 September 2022, Mr Martin sent a short text to a number of contacts giving them his new number. Mr Martin alleged it went to all contacts but the Court found that it only went to AEI clients that had previously been saved to Mr Martin's phone. AEI became aware of the text message on 8 September 2022 and wrote to Mr Martin requesting he comply with his post-employment restraints and return all AEI property. Between 1 and 8 November 2022, and despite an injunction from the Court being in place, 45 clients moved to MA Brokers. The majority had been directly solicited by Mr Martin, or indirectly through MA Brokers, with only some choosing to move of their own volition upon hearing Mr Martin had new employment.

What did the Court find?

As this was a New South Wales case, the Court considered the application of the Restraints of Trade Act. Justice Thawley confirmed the approach outlined by Justice Gleeson in Isaac v Dargan Financial Pty Ltd. First, the Court determines whether the alleged breach does or will infringe the terms of the restraint. Second, the Court determines whether the restraint, so far as it applies to that breach, is contrary to public policy. If it is not, the restraint is valid.

Justice Thawley remarked that Mr Martin voluntarily agreed to the restraint and acknowledged its reasonableness in clause 12.5 of his employment contract. Whilst a contractual consensus cannot be regarded as conclusive, it is a matter of some weight. Further, noting that insurance policies and books usually last for 12 months, the restraint lasting for a year was considered reasonable in the circumstances.

Justice Thawley ultimately found that Mr Martin had breached clause 12 as he used his connections and information obtained during his employment with AEI to solicit clients both directly, and indirectly through MA Brokers. Justice Thawley assessed damages at $500,000, taking into account the number of clients who had moved, their total expected revenue for AEI, the likely retention rate of all 45 clients and the impossibility of knowing if any would have left or stayed and renewed their policies.

The judgment can be accessed here.

2nd Chapter Pty Ltd & Ors v Sealey & Ors

By way of comparison, Paul Sealey and Jono Vickers-Willis were two former investment and financial advisory employees who held shares in Escala Partners. A third former employee, Will Allen, did not hold shares.

Each employee was covered by a non-competition agreement for a minimum of five years from the date a share purchase agreement was finalised.

These three employees commenced employment at LGT Crestone Wealth Management Ltd (LGT). Escala sought but failed to obtain injunctive relief restraining the three former employees.

During the substantive hearing, Justice Matthews of the Victorian Supreme Court confirmed that the party receiving the benefit of the restraint of trade (e.g. the former employer) has the burden of proving the enforceability of the restraint. That party must demonstrate that the restraint does no more than protect their legitimate interests, considered at the time of entry into the restraint, i.e. the date of the contract of employment.

What did the Court find?

Justice Matthews held that the protection of the goodwill of Escala's business was a legitimate business interest, and that Escala was entitled to enforce some restraints, but found that a five-year restraint (covering non-competition and non-solicitation) was unenforceable in respect of the three employees. Justice Matthews focused on the scope of the restraint, particularly with regard to the clause that prevented any of the employees from soliciting or accepting approaches from any clients of Escala, not just the employees' direct contacts. Her Honour found the breadth of the restraint was unreasonable considering the "negligible risk" where there was no personal relationship between adviser and client. Her Honour also held the length of the restraint was unreasonable considering the low number of shares that Sealey and Vickers-Willis owned in Escala.

The judgment can be accessed here.

Key takeaways

Employers should be mindful of the ACCC review into restraints, with recommendations to Government likely to be in support of limiting the use of non-compete clauses, particularly in relation to employees remunerated below a high income threshold.

Irrespective of the review, it is important to remember that to be enforceable, restraint clauses must be drafted such as to protect the employer's legitimate business interests, and not for the purpose of restraining mere competition.

Consideration could also be given to adopting NSW law as the governing law of the contract during drafting. The Restraints of Trade Act provides a simpler mechanism for enforcement of restraints than applying the common law tests.

For advice or assistance with restraints of trade in your organisation, please contact a member of our experienced employment and workplace team.