Do restraint clauses apply to redundant employees?

April 2009

You may have heard this story before. A key employee hatches a plan to leave and set up in competition. Clients are contacted, key staff are targeted and confidential information taken, all behind the employer's back. Then the employee leaves, without warning. The business is devastated. There is little the employer can do about it. This is because the employee has covered their tracks so proof of the deception is hard to find. Plus there is no post employment restraint in the contract of employment.

Many business owners fear this happening to them. The fear is legitimate. There are many recorded instances of employees doing just what is described above. This is why many businesses include post-employment restraints in their employment contracts. This is wise. A well drafted clause can provide a deterrent to employees tempted to do the wrong thing and some protection if they do.

A lesser, but nevertheless significant, risk arises where it is the employer who terminates the employment, whether for poor performance, misconduct or redundancy. Here there is obviously no opportunity in this case for the employee to secretly plan to compete beforehand, so confidential information can be protected. But the employee may still choose to set up a competitive business after they leave. This is where the risk comes in.

If the employee is an effective operator, the employer in such a case is exposed to new competition. This can be devastating, particularly for small businesses. Moreover, where the termination is a redundancy due to a downturn in business, the employer will have to face a new competitor for a shrinking market. Without the ability to restrict the employee this can be disastrous.

There is a popular misconception that post-employment restraints only apply to restrain a employee who has resigned in order to compete. That is such clauses are meant to deter the employee from being tempted to go behind the employer's back and take business from their employer. This is incorrect. The law is that if the clause is "reasonable", then it can be enforced against a former employee, regardless of whether the employee resigned or was terminated, including termination for redundancy.

So the answer to the question - do restraint clauses apply to redundant employees - is yes. But there is a catch. The restraint must be reasonable to begin with. If it is unreasonable, it will not be enforced. Therefore, if you are considering making redundant an employee who has a restraint clause in their contract you should first ask whether the restraint is reasonable and, therefore, valid.

What, then, is a reasonable restraint? This question is difficult to answer, as it will depend upon the facts of each case. This is why such clauses should be drafted with professional assistance. The following are a few pointers as to whether your restraint clauses are likely to be enforceable, whether in a redundancy situation or otherwise.

The starting point is that there are three kinds of restraints: non-competition, non solicitation of customers and non-solicitation of employees. Non-competition clauses are much harder to justify that non-solicitation clauses because they prevent the employee from working at all. Non-solicitation clauses are likely to be easier to enforce, because it may be easier to show there is a legitimate interest requiring protection namely your investment in your customers and staff.

Whichever category the restraint is in, a valid restraint must only do what is reasonably necessary to protect your business's legitimate interests. In determining what is reasonable, it will be relevant to consider the geographical coverage of the restraint (i.e. have you only restrained the employee from setting up a competing business within 1km of your business, or within the rest of the country?) and the duration (i.e. have you only sought to restrain for 3 months, or 5 years?). Other relevant factors include the width of the activities to be restrained, as well as payments made to the employee.

The reasonableness of a restraint clause will be assessed at the time the contract was entered into, and not at the time the employee's employment ends or at the time the employee breaches. If the clause is challenged, it will be up to you as employer to prove the reasonableness of the restraint.

Finally, restraints - which must be reasonable - should be distinguished from clauses which protect your intangible assets such as confidential information and trade secrets after the employment has ended. Confidential information may include client lists, business information, plans, sales and pricing information, and formulae, just to name a few. As these clauses are designed to protect your property, and not to restrict the activities of a trader, they do not need to be reasonable to be valid. These clauses therefore are likely to be upheld more readily than restraints of trade.

However, bear in mind that such clauses only protect information which is truly confidential and proprietary, and cannot restrict the use by the employee of general know how gained during the employment.

In conclusion, if you are considering making an employee (particularly a senior employee) redundant check first whether you have a post-employment restraint clause, and consider obtaining advice as to its enforceability before acting. If you do not have such clauses in place, you should consider including one, to protect your business in the future.

For further information please contact Mark Hemery, Principal, at mhemery@talbotolivier.com.au or Jennifer Keane, Solicitor, at jkeane@talbotolivier.com.au.

Return to Workplace Relations ePublications.