non-compete clause, also commonly called a restraint of trade clause, is often found in contracts. You may find such provisions in employment agreements, sale of business agreements, franchise agreements and contracts where one party has access to confidential information and intellectual property of the other party. This article explains how a non-compete clause works in Australia.

What is a Non-Compete Clause?

A non-compete clause aims to prevent a party from using confidential information, intellectual property (IP) and their general know-how to compete with the business they no longer have a contractual arrangement with. However, these restraint clauses are only enforceable in Australia if they are considered reasonable to protect the legitimate business interests of the party who benefits from the clause.

This helps to ensure that a party is not unnecessarily prohibited from competing in the open market. They could be an employee leaving their employment or a business seeking future business opportunities.

Using A Non-Compete Clause

If a party deals with the day to day activities of a business, they may have access to confidential information and IP of the business. Further, the business may need to disclose confidential information with third parties to operate effectively in the market.

A non-compete clause helps to protect a business’ interests by preventing the party from using confidential information and engaging in specific competitive activities. Here are some examples of situations where a contract may include a non-compete clause:

  • Employment: A senior or managerial employee in a recruitment agency may be restricted for six months from moving into future job positions in the human resources industry.
  • Franchising: A franchisee operating a café business may not be able to operate a café in the same location.
  • Sale of Business: A vendor of an accounting business may not be able to operate a new accounting business for three months after the sale.
  • Manufacturer: A manufacturer of food products may not be able to produce similar food products for businesses.

The rationale of the above examples is the desire to protect business interests such as goodwill, confidential information and IP.

Possible Restricted or Competitive Activities

The restricted activities generally fall under three headings:

  1. Non-compete: This clause prevents a party from competing with another party. For example, preventing an ex-employee seeking employment in a competitive business.
  2. Non-solicitation: This clause prevents a party from soliciting businesses or individuals that may have had a relationship with the business previously. For example, clients or customers.
  3. Recruitment: This clause is similar to the non-solicitation clause but refers to internal soliciting. It prevents a party from soliciting key people in the business, for example, senior employees or managers.

Enforcing a Non-Compete Clause

When analysing a non-compete agreement, a court will need to consider whether it is reasonable, and thus enforceable. A court may consider three main factors, including:

  1. the geographic area where the non-compete clause applies;
  2. the activities that a non-compete clause seeks to restrain; and
  3. the period of time for which the provision applies.

The court will balance the restriction against the business interests of the party seeking to enforce the non-compete clause.

For example, a marketing firm’s employment contract might attempt to prevent former employees from working for any Australian media company for three years post-employment. It is unlikely that this clause will be deemed reasonable, as it is so broad that it would prevent a former employee from engaging in the free market. On the other hand, a provision that prohibits them from poaching any clients from the former employer for one year would be reasonable as it protects the legitimate interests of the employer.

A non-compete clause will also only be enforceable if it protects a genuine interest that can be valued. The party seeking to enforce the non-compete clause has to prove that it has such an interest. Therefore, they have to show that the restrictions are reasonably necessary. A business may protect the following commercial interests:

  • confidential information;
  • IP;
  • know-how;
  • trade secrets; or
  • goodwill.

Applying the Non-Compete Clause

The non-compete clause may be drafted in a way where more than one individual is prevented from undertaking the competitive activities. For example, individuals may be restrained in their capacity as directors or shareholders of a company or as trustees of a trust. The clause prevents any individuals within a particular role from setting up a competing business or entity.

Unreasonable Non-Compete Clauses

A non-compete clause operates to restrict one party from undertaking competitive activities, which may also include employment. Trying to enforce an unreasonable non-compete clause is against the public policy of a market economy. Doing so may restrict a party from participating in the economy. A provision may be unreasonable if it prevents a party from offering their skills or undertaking further business activities.

A court can sever certain sections of a clause if it considers the clause (or parts of the clause) to be unreasonable. Therefore, many non-compete clauses are cascading.

For example, the non-compete clause may apply for 12 months, or if 12 months is not reasonable, then six months.

Effectively, the court has the flexibility to choose from a mixture of possibilities. Hence, a modified version of the clause may be enforceable after the court decides which cascading term is most reasonable.

Questions to Consider

If you are conducting business or employing people, it is useful to consider whether a non-compete clause will be appropriate or reasonable. To do so, you should determine the likelihood of the other party accepting such non-compete provisions.

The following questions may assist you in determining whether a non-compete clause is necessary:

  • What activities do you wish to prevent the party from undertaking?
  • For what time period do you want the party to refrain from undertaking the activities?
  • Do you want to prevent a party from undertaking activities throughout the world or within a specific geographical area? Are the geographic regions reasonable to protect your interest?
  • What is the interest that you are attempting to protect?
  • Does the other party acknowledge and agree that the interests have a value worth protecting?

Key Takeaways

A non-compete clause is an essential provision in a contract if you wish to protect your legitimate business interests. Further, when drafting or entering a contract, you should thoroughly review any non-compete clauses to ensure that they are reasonable and do not restrain your participation in the market economy.

If you need legal advice or assistance drafting a non-compete clause, get in touch with LegalVision’s contract lawyers on 1300 544 755 or fill out the form on this page.

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