Non-compete clauses are in the spotlight following significant legal developments in Australia and abroad. Could it be the time of reckoning for these restraints?
Non-compete clauses are currently under scrutiny from various quarters.
Broadly speaking, non-compete clauses are a form of post-employment restraint that prohibit an employee from working for a competitor of their previous employer for a specified period in a defined geographic area.
The rationale for non-compete clauses being imposed on departing employees is to protect the legitimate business interests of the former employer, usually confidential information and customer relationships. This protection, however, needs to be balanced against the right and need of the former employee to ply their trade or profession and earn a living.
This balance is why there is a question as to the enforceability of non-compete restraints, with courts called upon to adjudicate as to whether a non-compete restraint should be enforced against a former employee and, if so, to what extent (in terms of time period and geographic scope).
A court will not enforce the restraint beyond what is reasonably necessary to protect the legitimate business interests of the former employer seeking to rely upon it. As a rule of thumb, it’s usually senior employees who have significant access to confidential information and customer relationships who may have their non-compete clauses enforced.
As such, there can be a proper basis for imposing a non-compete restraint against such employees, as they can damage the business interests of the former employer by moving to a competitor. There is a real prospect a court will enforce a non-compete in such circumstances.
However, there is an increasingly influential view that it may be unfair for employers to impose restraints on relatively junior or lower-level employees who have not had access to confidential information or customer relationships.This unjustifiably keeps those employees from opportunities with other employers, and impedes labour market mobility. In these circumstances, a court would likely give any attempt by an employer to enforce such a restraint against a former employee short shrift.
Unfair dismissal case brings non-compete clause into question
In a recent unfair dismissal decision, the Fair Work Commission considered the impact of a non-compete clause imposed on an applicant on his obligation to mitigate the loss from his dismissal.
The applicant in this case was a salesperson selling grouting and grouting services. The FWC addressed the issue of the non-compete clause and its relevance to mitigation of loss.
Deputy President Colman, by way of background, observed:
“Section 392(2)(d) requires the Commission to consider the efforts of the person to mitigate the loss suffered as a result of the dismissal. [the applicant] said that he had applied for hundreds of jobs on ‘Seek’, including sales jobs, in which he had a lot of experience. However, he said that he had not applied for jobs in the same sector as his previous work, because of the presence of a post-employment restraint provision in his contract of employment (clause 10.1).
“This stated that for a period of 12 months after the termination of his contract of employment, [he] was not to work as an employee or contractor or advisor or in any other capacity in any business which was ‘engaged in activities substantially similar or identical to the Company and provides services substantially similar or services offered by the Company.’”
Deputy President Colman then provided commentary on the restraint, relevant to the applicant but also of interest more broadly on the issue of post-employment restraints imposed on ‘ordinary’ workers:
“One wonders why such restraint of trade provisions are so commonly found in the contracts of ordinary workers and whether they really protect any legitimate business interest of the employer, or merely serve to fetter the ability of workers to ply their trade, and to reduce competition for labour and services.
Ordinarily, one would expect a person to have applied for jobs in the sector of their expertise as a reasonable step in mitigating loss. How the presence of a non-compete provision in his contract explains [the applicant’s] decision not to do so.
“A court will not enforce the restraint beyond what is reasonably necessary to protect the legitimate business interests of the former employer.”
Although the provision is most likely unenforceable on the basis that its scope is unreasonable, an ordinary worker cannot be expected to know this, and it is understandable that [the applicant] would not want to risk embroiling himself in a legal controversy by acting contrary to an express provision in his contract.”
As a result, the FWC refused to reduce the amount of compensation awarded to the applicant for unfair dismissal.
This decision highlights the disconnect between legal principles for non-compete clauses and how many employers enforce these restrictions on employees, regardless of whether they had enough access to confidential information or customer relationships to justify the restrictions.
This situation often arises from employers using pro forma employment agreements which contain, as part of their standard terms, post-employment restraints such as non-compete and non-solicit clauses.
Often little thought or consideration is given to whether to include the post-employment restraints or to their ultimate enforceability if tested. Indeed, there may be no intention on the part of the employer to ever enforce the restraints.
Of course, employees are not to know this – as far as they are concerned there is a post-employment restraint in their contract and, as Deputy President Colman observed, they may not want to be potentially drawn into a legal dispute with a former employer and so comply with the restraint, even if the employer had no intention of enforcing it.
Reviews of non-competes in the USA and Australia
This decision comes at a time when post-employment restraints are under review, both in Australia and the USA.
In the USA, the Federal Trade Commission (FTC) has taken the drastic step of banning non-compete clauses in employment contracts completely.
Only existing non-compete clauses for senior executives (a cohort of less than 0.75 per cent of workers in the US) will continue to be enforceable. Moving forward, there can be no new non-compete restraints for any employees, including senior executives.
In Australia, the Competition Review Taskforce is presently examining non-compete clauses and various other form of employment restraints, with submissions being sought.
The Issues Paper released by the Competition Review Taskforce provides this summary:
“Several issues have been identified relating to the use and impact of non-compete clauses. Many issues identified in empirical analysis have been affirmed as practical issues affecting Australia today through the Competition Review Taskforce’s early engagement, and include concerns about:
- The “chilling effect” of restraint clauses on worker mobility, particularly among lower-income workers, to choose better-paying jobs, and the ability for businesses to start up, recruit talent and grow.
- The high cost of litigation, the lack of clear guidance and ‘bright line’ rules, and the use of cascading clauses or the ‘blue pencil test’, which can leave both workers and businesses with an unclear understanding whether an agreed restraint will be upheld as reasonable and enforceable.
- The economic consequences of potentially inefficient allocation of labour and information, which may be hampering productivity growth and innovation.”
These are reasonable concerns, but they can be addressed without banning non-compete clauses altogether.
In determining the enforceability of such restraints, the courts, through principles developed over decades of judicial consideration, carefully endeavour to ensure an appropriate balance is struck between the right of employers to protect their legitimate business interests and the right of employees to change positions and earn a living.
Do you think non-compete clauses should be banned? Let us know in the comment section.
Michael Byrnes is a Partner at Swaab. A version of this article first appeared on Swaab’s website. You can view the original here.
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For many years as an HR professional the topic of restraint clauses invariably comes up. My position on this is to apply fairness and what is reasonable. I think Restraint Clauses have a part to play but you must consider the particular circumstances for the exiting individual and the business equally. I agree that for lower level employees that have little or no access to confidential information or influence over customers the restraints are not worth having. The onus is on the business to protect their IP and relationships over the duration of employment and beyond and not rely on… Read more »
Banning non-compete clauses outright defeats the purpose of why they were introduced in the first place – to protect the legitimate interests of a company. However, their introduction into less-than-senior role contracts where the employee has no access to confidential information and does not create close customer relationships is troublesome, and my advice to employers was always that they were likely to be unenforceable, based on the reasoning that everyone is entitled to earn a living. I had never considered that employees would feel themselves bound by the clauses, or that they might affect the outcomes of a Fair Work… Read more »
What if Restraint Clauses have been used by a business to restrain lower employees from taking clients when they leave and move to another business (non-solicitation)? This would still seem like a fair justification of the use of non-compete clauses to all employees regardless of their seniority. Losing customers when an employee leaves can cause significant loss to an employer and I believe is still a valid use of this type of contract clause. The ability to understand the reasonableness and enforce this type of contract seems to be the greater issue.
I think that it should be taken out for everyone other that upper management in big corporations. The industry I was in previously had businesses that had these clauses in their contracts, and with the limited number of qualified people in the industry, made it very hard to fill casual positions. There were a few companies that refused to allow their workers to seek work outside of their company even if they didn’t have the work for them. This made finding staff very hard when it came to seasonal work. In this industry it is vital that businesses work together… Read more »