Are Restraints of Trade Enforceable?

I often hear employers and employees say restraint of trade clauses are not enforceable and that we don’t need to bother with them.

That’s not exactly true.

In fact, not so long ago the Employment Court encouraged us all to take post-employment restraints more seriously when it declared:

‘Gone are the days, if they ever existed, when an employee could confidently sign up to a restraint and then breach it in the bold expectation that “those things are not worth the paper they are written on”.’

So what are restraints of trade clauses and when are they enforced?

WHAT ARE RESTRAINTS OF TRADE?

In the employment law context, restraints of trade are specific clauses in employment agreements under which employees agree not to do something that they would otherwise be free to do after they leave their job.

The most common types of restraints of trade are agreements that the employee will not poach the employer’s clients or staff or that the employee will not work for any of the employer’s competitors.

Restraints are typically limited in scope by reference to:

  • the length of time that they will apply for after the employee has left their job; and
  • the geographic area in which the employee agrees to limit their activities.

WHEN WILL A RESTRAINT OF TRADE BE ENFORCEABLE?

The starting point is that restraints of trade are unenforceable. In this way, the law errs on the side of ensuring every person is free to make a living in their chosen field of work.

This is a key reason for the perception that restraints of trade are unlikely to be enforced. We consider it unfair that anyone would be prevented from earning a crust doing what they may have devoted their working lives to.

But that is just the starting point.

The Employment Relations Authority or the Employment Court will then go on to consider whether there are good grounds why a particular restraint clause in an employment agreement should be enforced.

The onus is on the employer to show that the restraint of trade:

  • has been fairly bargained for;
  • is necessary to protect the employer’s business; and
  • only goes as far as the employer requires.

If the employer can show these three things, then the restraint of trade will likely be enforced. We’ll examine each element in turn.

Was it fairly bargained for?

As restraints of trade are a significant curb on an employee’s freedom, the employer must show that the employee was given a fair deal in return for agreeing to the restraint.

Where the restraint of trade is in an employment agreement from the beginning of the employment relationship, the offer of employment itself is seen as a fair bargain for the employee agreeing to be restrained in some way when they leave.

However, if the restraint of trade is entered into sometime later in the employment relationship, there must be a separate payment for it. This can be a one-off payment, like a lump-sum for agreeing to the restraint, or it may be linked to an increase to the employee’s remuneration that they will only receive if they agree to be bound by the restraint.

The key thing is that the employee must be shown to have received something of value in return for having bound themselves to not taking certain action after their employment ends. Lawyers call this “consideration“. Without that, the restraint of trade will not be enforceable.

Is it necessary to protect the employer’s business?

Next, the employer must show that the restraint is necessary to protect their business in some way.

The Authority and the Court are not interested in preventing mere competition. For the most part, competition between businesses is a good thing and should be encouraged. But they will step in if the competition is unfair.

Where an employer seeks to enforce a restraint of trade clause, it is in essence arguing that the employee has an unfair advantage.

The employer may have entrusted the employee to deal with its clients and exposed the employee to its confidential information. The employer does not want to let the employee abuse that trust by exploiting those client relationships or information in a way that could harm the employer’s business.

Often, the employer will say that their former employee has the ability to:

  • take their clients to a competing business;
  • persuade their staff to leave for a competing business; or
  • use trade secrets or other confidential information for the benefit of a competitor.

In the above cases, the employee could cause the employer’s business to lose market share or suffer other losses.

But the risk of loss must be realistic. If the former employee has never dealt with any of the employer’s customers, it is unlikely that the employee will have any ability to persuade them to move to a competitor.

Similarly, if the employee’s exposure to confidential information has been minimal, then the employer may find it difficult to show there is some risk that must be guarded against.

Is the scope reasonably necessary?

Finally, the employer must show that the restraint only extends as far as reasonably necessary to protect those aspects of the employer’s business that require protection.

The following are some of the factors that can be weighed in the assessment of whether the restraint is reasonable:

  • Is the length of the restraint reasonable? The Court has indicated that a restraint of one year is at the upper end of what will be considered reasonable in most cases. Restraints of three months are regularly enforced. If the employee has already served a period of garden leave, this will also be taken into account.
  • Is the geographic scope reasonable? The Court did in one previous case suggest that all of New Zealand would not usually be reasonable. However, in an era where the scope of our work is less defined by geography, this factor may be less likely to be relevant.
  • How much was paid for the restraint? The amount paid for the restraint, if not entered into at the outset of the employment relationship, may have a bearing on the extent to which the restraint will be enforced.

If the restraint is not reasonable, that is not the end of the matter, because the Authority and the Court have the power to vary the scope of the restraint under the Illegal Contracts Act. In that event, the scope of the restraint that is enforced may be very different to what the parties appeared to have entered into when they signed the agreement containing the restraint clause.

A COFFEE BREAK

A clear example of an enforceable restraint of trade concerned a barista working for a Wellington coffee company, Fuel Espresso.

The barista entered into an employment agreement that contained a restraint of trade preventing him from setting up in competition within 100m of the employer’s coffee outlets within three months of leaving.

Soon after leaving his employment with Fuel Espresso, the barista set up a competing coffee cart 70m down the road from one of his former employer’s coffee outlets.

Ultimately, the case came before the Court of Appeal, which had no trouble in declaring that the restraint clause was “plainly reasonable”. The former employee was ordered to stop acting in breach of the restraint clause until the expiry of the three-month restraint period.

CONCLUSION

The enforcement of restraints of trade is not always a straightforward matter, but that is no barrier to enforcing them in appropriate cases.

They may very well be enforced, provided the employer can show that the restraint clause:

  • has been fairly bargained for;
  • is necessary to protect the employer’s business; and
  • only goes as far as the employer requires.

In those cases, both the employer and the employee may find that the restraint clauses are well worth the paper they are written on.