Restraint of Trade in Employment Contracts and Commercial Agreements

Restraint of Trade

What is a Restraint of Trade (ROT)

ROT clauses are commonly found in employment and commercial  contracts.  These clauses are intended to protect the employer’s legitimate business interests.

Scope of ROT clauses

The scope of restraint of trade covenants can depend on the nature and context of the agreement. While there are some distinctions, the principles behind the enforceability of ROT covenants can be universally applied in the below three contexts.

Are Restraint of Trade clauses enforceable?

The legal term used to describe the nature of these covenants are that they are “prima facie void” i.e. they are presumed unenforceable, unless the restraint is reasonable in both the parties’ interests and also in the public interest.[1] When ROT covenants are drafted, it is prudent that the activity sought to be restrained is properly described, in addition to confining the restraint geographically and with time limitations. This is because unlimited restraints (i.e. worldwide) and restraints which are not limited in time, are likely to be found as unenforceable.

ROT clauses in Employment Agreements vs. Commercial Agreements

Various distinctions can be made between ROT covenants in employment contracts, and ROT covenants in commercial transactions (such as franchising and sale of business agreements). Some key differences between ROT covenants in these contexts are set out in the table below:

Employment Sale of Business Franchise Agreements
ROT covenants are contained in a traditional employer-employee contract. ROT covenants are contained in a vendor-purchaser agreement. ROT covenants are contained in a franchisor-franchisee agreement.
ROT covenants in employment contracts are used to balance:

 

(a)  “Employees who have an interest in plying their trade;

(b)  Employers have an interest in protecting their business; and

(c)   The public have an interest in ensuring that employees are able to perform work and there is efficient use of all economic resources”.[2]

 

ROT covenants in sale of business agreements are used to balance:

 

(a)  “The need to protect a vendor’s business interests;

(b)  The purchaser’s right to earn an income; and

(c)   The public’s interest in ensuring a competitive marketplace”.[3]

ROT covenants in franchise agreements are used to balance:

 

(a)  “The need to protect a franchisor’s business interests;

(b)  The franchisee’s right to earn an income; and

(c)   The public’s interest in ensuring a competitive marketplace”.[4]

 

Generally enforced by the employer. Imposed on the vendor. It may be necessary to secure ROT from directors or shareholders of the vendor, if the vendor is a corporation.[5] Enforced by the franchisor.
Protects employers from employees working for any competing business, not to use confidential information, not to solicit former employer’s customers or clients and to protect business relationships. Protects the business’s commercial interests and goodwill. Protects the franchisor’s commercial interests and goodwill.

ROT covenants in employment contracts are more carefully scrutinised by courts than similar terms in other contexts, such as ROT covenants arising from commercial transactions.[6] This is for a number of reasons. In employment contracts, there is “a greater danger for abuse of superior bargaining position than other contexts”.[7] This recognised inequality of bargaining power is not so prevalent in a commercial setting. This is because parties in commercial transactions between corporate entities are focused on protecting a business’s commercial interests and goodwill. As such, these parties have a greater ability to negotiate the terms of the agreement, which is easier facilitated between two parties who are in equal bargaining positions from the outset of the transaction.

[1] Nordenfelt v Maxim Nordenfelt Guns & Ammunition Co Ltd [1894] AC 535.

[2] Mark Irving, The Contract of Employment (LexisNexis Butterworths, 2012) 1040.

[3] Bywaters Timms Lawyers, Enforcing Restraint of Trade Clauses in Franchise Agreements, <http://www.bywaterstimms.com.au/images/Enforcing-Restraint-of-Trade-Clauses-in-Franchise-Agreements.pdf>.

[4] Ibid.

[5] CCH, Australian Buying and Selling Businesses: Personal Property, vol 1 (at 9-100).

[6] Geraghty v Minter (1979) 142 CLR 177, 180; Lindner v Murdock’s Garage (1950) 83 CLR 628, 641.

[7] Irving, above n 2, 1046.