Many Australian businesses use contractual restraints of trade to protect confidential information and customer relationships. In this update we answer frequently asked questions about the future of restraints of trade in Australia, and consider options available to companies in the event that some types of restraints are no longer available.
Are restraints of trade still allowed?
Yes – in the sense that the rules that have applied for years still apply for the moment.
Restraints of trade can form part of an employment arrangement (usually in the employment contract or a deed) and sale of business agreements and will be valid and enforceable in certain situations.
There are a fairly complicated set of both rules and principles that Courts apply in determining whether a restraint will be valid, and warranting remedy, where it has been or might be breached. The basic rule is that a restraint will be unenforceable unless there are special circumstances where a restraint protects a legitimate interest recognised by law. This interest must be recognised by the law and deemed reasonable by the Court both as between those who agreed to it, and taking into account the public interest.
Generally, Courts take a more permissive approach to sale of business restraints (which typically restrain the vendor from accepting business from former clients of the business sold for a period of time). The idea is that sale of business restraints are a public good because they benefit trade. Courts typically need much more convincing that a restraint in an employment agreement is enforceable.
When is a restraint reasonable and enforceable?
This depends on the particular circumstances. A Court will consider the scope of the restraint (the activities – such as not competing or poaching staff), how long the restraint applies, and its geographical area.
For more detail, click here to receive a copy of my article in the Australian Business Law Journal.
Are employment restraints about to be banned in Australia?
Short answer is no, not yet, but their future looks uncertain.
Businesses that use restraints of trade to protect confidential information going to competitors when employees leave, or purchasers acquiring a business who want to protect goodwill will be keen to understand the future of restraints of trade in Australia. The Australian Competition and Consumer Commission (ACCC) is presently reviewing whether restraints will be banned in Australia following a referral from the Federal Government.
We’ve set out key information about the state of play below. If you see something important and need more insight, speak to any of our partners. We have had deep involvement in many of the most contentious and high stakes cases decided in Australia and have broad advisory expertise in this area.
Are there many types of restraint and which are being reviewed?
Yes, there are many different types of restraint. They include:
- Non-competition restraints which forbid working for a particular company or in a particular industry.
- Non-poaching restraints which forbid soliciting or encouraging staff or clients to leave one organisation and join another.
- Sale of business restraints which are typically a form of non-competition restraint given by a vendor to the purchaser of a business promising not to set up in competition and take clients or staff away.
We understand that all of these types of restraints are under review.
If we were to speculate, what changes will the Government make?
It depends much on what recommendations the ACCC provides the Government with, and then, of course, whether the Government has the numbers in Parliament to implement any recommendations it accepts.
Judging by what has occurred in other countries, most notably the United Kingdom and the United States of America (who Australian politicians commonly look to for ideas), consideration will be given to:
- banning non-competition restraints contained in employment contracts;
- limiting non-solicitation of client or staff restraints to a short period of time, say three months maximum; and
- only permitting enforcement of a restraint where there is specific and separate payment for the period the restraint operates.
It is likely that sale of business restraints will be left alone or subject to additional criteria. We do not anticipate them being banned altogether.
Restraints of trade have been in place for hundreds of years. Why is the Government reviewing them now?
The catalyst for the review in Australia was a 2023 decision by the Federal Trade Commission (FTC) in the United States of America (similar to Australia’s ACCC which enforces competition laws) to issue a rule that all employment non-compete agreements (but not sale of business agreements) be banned, and even existing non-compete agreements be rescinded.
Although this FTC rule is not in effect whilst consultation about the proposal is occurring, the proposed change has unleashed quite the energetic backlash with more than 11,000 submissions being filed with the FTC about the proposals, with plenty of media making the case both for and against restraints. This is mostly due to US legislative activity expanding to impose restrictions on confidentiality and non-disparagement agreements following a separate decision from the National Labour Relations Board which found an increase in corporate suppression of misconduct and ill-treatment of shareholders, consumers and employees.
Interestingly, other employment restrictions including non-disclosure and non-solicitation agreements are exempt from the ban. The affected ability for employers to include confidentiality and non-disparagement clauses in separate agreements has been proposed in conjunction with the ban on non-compete clauses on the basis that these provisions provide an unfair method of competition. In the past, employees have been found to be best positioned to reveal employer misconduct as a result of their access to private, in-house information. This has in turn, attributed to a growing concern for employer abuse in the implementation of strategic confidentiality provisions and contractual clauses aimed at preventing an employee from exercising workplace rights and disclosing misconduct and wrongdoing.
The criticisms of the FTC proposal are many and varied, including that:
- The FTC does not take into account the many positive reasons for non-compete agreements, such as promoting innovation and giving companies a better chance to protect confidential information;
- The FTC does not have congressional authority to make the rule banning non-competes that it proposes – this issue will be determined through litigation in 2023 and 2024; and
- The reasons given by the FTC for banning non-competes lack substance. For example, the FTC cites the overuse of non-competes to restrict the mobility of low-earning employees, but does not explain why senior employees who have confidential and commercially sensitive information and move from a company to a direct competitor should not be subject to such restraints.
A number of States in the U.S. including California, North Dakota, Oklahoma, and Minnesota have now proposed State legislation to ban non-competes. Other States in the U.S. including Washington, Oregon, Nevada, Colorado, Illinois, Maine, Massachusetts, Rhode Island, Maryland, Virginia, and the District of Columbia have enacted legislation which is restraint friendly or unfriendly. You can find a State-by-State comparison prepared by our United States colleagues here.
The UK government appears to have followed suit shortly after the FTC’s announcement in proposing a statutory limit on the length of non-compete clauses of three months. The UK’s position aims to boost flexibility in the labour market and unleash greater competition and innovation. It is unclear from the UK’s proposal how this is to affect current in-place non-compete clauses.
In the case of Europe, no major jurisdictions have banned non-competes completely. They remain enforceable, given the commonality for employers to opt to embed non-compete clauses in employment agreements of essential employees. Many jurisdictions have a limit of 12 months on non-compete periods, requiring some non-compete periods to be paid fully or partly as is the case in France, Spain, Italy, Belgium, Denmark, Poland, Norway, Portugal, and Germany.
There is specific legislation in New South Wales that helps companies enforce restraints. Will that be changed?
We can only speculate at this point. If the Federal Government changes the law concerning restraints (for example, by placing a strict cap on the duration of employment restraints), it is likely the change in law will apply uniformly across the country, which will alter the position in New South Wales.
We are common users of restraints of trade in our business. What can we do now to put ourselves in a good position in case employment restraints are not available in the future?
Restraints are very common in some industries and professions. In the only Australian study examining the prevalence of restraints, Chia and Ramsay (2016, Australian Journal of Labour Law) found that restraints are most commonly used in financial services, professional services, technology, real estate, recruitment and in wholesale and consumer products businesses.
Although a good restraint of trade can offer important benefits to a business if it is well drafted and used for the right reasons, it is important to bear in mind that there are other means to protect confidential information. Sections 182 and 183 of the Corporations Act 2001 (Cth) prohibit directors and employees improperly misusing information obtained through their employment. Further, equitable rules regarding the misuse of confidential information, agreed contractual provisions, legislation protected trade secrets and common law protected intellectual property all ensure the security of privileged information.
The issue is that none of the means described above offer the same protection that a good restraint of trade does. For example, assuming a valid restraint has been agreed upon, a top salesperson who leaves to join a competitor can be restrained for a reasonable period to (a) enable the former employer to replace them, and (b) provide a replacement salesperson with a chance to meet clients and form customer connections. Absent a restraint, there are no strong legal protections that deal with this kind of situation.
In terms of what can be done to protect business assets, such as confidential information or critical customer connections in the face of a potential ban on restraints, we can take some guidance from what companies have done in some U.S. States, such as California, where restraints were banned years ago. Over time, a number of legal and economic instruments have been developed and deployed including:
- Use of choice-of-forum clauses (where there are differences between States) that may enable the law of a different forum to regulate the contract;
- Stronger drafting of confidential information protection contained in the employment contract or Non-Disclosure Agreement clauses (which can be used throughout the employment not just at the start);
- In industries where this solution is appropriate, invention assignment agreements (typically used in technology companies and universities) where the employee agrees in advance that any inventions developed in the course of the employment belong to the employer;
- Use of deferred compensation mechanisms to encourage employees to stay with a firm or to leave on terms which protect confidential information and customer relationships; and
- Increased use of legislation protecting trade secrets and confidential information.
Other novel solutions also exist in particular industries and professions.
Is there merit in the criticism of restraints of trade, that they suppress wages and trap employees in jobs they don’t like?
This is a contentious topic, and there is no straightforward answer. Much depends on the stance taken on some philosophical issues such as whether employees should ever be in a situation where they cannot freely move around in a labour market and pursue their own best interests.
If it is accepted that there is a trade-off to be struck between labour mobility and the protection of company interests, such as confidential and commercially sensitive information or investment in staff and clients, the issue is where the appropriate trade-off should be.
Various overseas studies have looked closely at this issue from different perspectives include a macro whole of economy perspective, a business level perspective and an individual employee perspective. For example:
- Ronald Gilson from Columbia Law School emphasised that the success of Silicon Valley in California is in large part attributable to the State ban on restraints. Knowledge spillovers between firms, so the argument goes, allow ideas to spread to where they are most likely to be commercialised – which accelerates innovation and is good for the economy and society.
- By analysing a large volume of patent and other data, Agrawal, Cockburn and McHale (2006, Journal of Economic Geography) noted that it is social ties between people that results in idea and information flows. These researchers found that even after an inventor had moved companies or geographies, knowledge flow at the old location was 50% higher than when they had lived and worked there. This indicates that personal relationships endure over time, space and organisational boundaries. These researchers would not consider restraints a major variable impacting idea and information flows.
- In a thorough and long paper, Posner, George Triantis and Alexander Triantis (2004, Olin Working Paper No. 137, University of Chicago Law & Economics) considered the issue from an economic efficiency perspective (that is, what is the correct balance point between labour mobility and employer investment in human capital), and concluded that the choice and drafting of a restraint can deal with these tensions, although there are economic incentives for both contracting parties to agree to excessively broad restraints upfront which can be a problem if they cannot be renegotiated at a later date.
- Arup, Dent, Howe and Van Caenegem (2013, University of New South Wales Law Journal) considered the impact of legal practice (that is, how the law works in practice) upon the enforceability of restraints of trade, and found that when an employee leaves and hard bargaining occurs under circumstances of uncertainty concerning whether the restraint will be enforced, often the former employee is at a financial and expertise disadvantage unless the new employer is willing to become involved and to provide financial and legal support.
Subscribe to receive the next Workplace Law & Strategy blog direct to your inbox.