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When will a restraint of trade clause be enforceable?

18 October 2022

#Workplace Relations & Safety

Published by:

James Phillips

When will a restraint of trade clause be enforceable?

In the recent appeal judgment of McMurchy v Employsure Pty Ltd; Kumaran v Employsure Pty Ltd [2022] NSWCA 201, the Court of Appeal of New South Wales has upheld a decision that a nine-month post-employment restraint clause was reasonable and enforceable against a former sales manager who joined a competitor’s business. The court also upheld the finding that the former sales manager had poached a colleague in breach of his duties owed to his former employer.

Background

Mr David McMurchy was employed as a sales manager for Employsure, a company that provides software programs to manage and automate human resources functions for small and medium-sized businesses. Mr McMurchy’s contract of employment included the following clauses:

a confidentiality clause which required him to refrain from disclosing or misusing confidential information

an exclusive employment clause, requiring him to devote his time, attention and skill during normal business hours to his duties for Employsure, and to faithfully and diligently perform his duties and in doing so promote the interests and prosperity of Employsure

a post-employment restraint clause that required him not to be engaged as an employee or consultant in any business in competition with Employsure.

Regarding the post-employment restraint clause, the contract stipulated a non-compete period of 12 months, nine months, six months or three months. Like many non-compete clauses, it was a ‘cascading’ clause, which means that if a court finds the 12-month period unreasonable and unenforceable, then the nine-month period will apply. If nine months is unreasonable, then six months will apply, and so on. Cascading clauses are also used for geographical constraints, such as in this case where the contract stipulated a non-compete area of Australia, New South Wales, or Sydney.

Mr McMurchy accepted a position as a manager of a sales team for a competitor company, ELMO Software Ltd. At that time, Mr McMurchy gave Employsure four weeks’ notice of his resignation. However, his resignation was ineffective as the contract of employment provided for a notice period of three months to terminate his employment. Employsure subsequently gave Mr McMurchy three months’ notice of termination, put him on “gardening leave” and directed him to remain available during business hours to respond to queries and carry out duties as needed.

On the same day he accepted his position with ELMO, Mr McMurchy provided ELMO and its recruiter names of Employsure sales employees whom they could poach. He also approached Mr Arumugam Kumaran, a Business Sales Consultant with Employsure, and told him about a role with ELMO.

Employsure then commenced court proceedings against Mr McMurchy and ELMO and obtained interlocutory orders restraining him from working for ELMO until the determination of the proceedings.

Mr Kumaran, under his employment contract with Employsure, was subject to effectively the same non-compete and confidentiality conditions as Mr McMurchy.

At about the same time as Employsure commencing proceedings against Mr McMurchy, Mr Kumaran gave his notice of termination to Employsure and accepted an offer of employment with ELMO as an account executive.

This was shortly followed by court proceedings by Employsure against Mr Kumaran and ELMO, which also resulted in interlocutory orders restraining Mr Kumaran from working for ELMO.

The decision

Approximately seven months later, following a trial, Justice Sackar of the Supreme Court of New South Wales issued his judgment in favour of Employsure. His Honour made the following findings:

Mr McMurchy breached the exclusive employment clause of the employment contract by taking up employment with ELMO before the end of the three-month termination period

the post-employment restraint period of nine months in Mr McMurchy’s contract was reasonable and enforceable

Mr McMurchy breached the requirement under his contract to promote the interests of Employsure by encouraging and inducing Mr Kumaran to leave his employment and join ELMO, and that he had also breached his fiduciary duties owed to Employsure

the post-employment restraint period of nine months in Mr Kumaran’s contract was reasonable and enforceable.

Justice Sackar’s decision resulted in declarations to the effect that the injunctions that restrained Mr McMurchy and Mr Kumaran were appropriate and that ELMO had knowingly assisted Mr McMurchy in his breach of fiduciary duty.

Mr McMurchy, Mr Kumaran and ELMO lodged an appeal against Justice Sackar’s decision.

The appeal

In deciding the appeal, the Court of Appeal weighed up what were Employsure’s legitimate interests that it needed to protect by restraining Mr McMurchy and Mr Kumaran from working for a competitor.

An employer can only enforce a clause of an employment contract to restrain its employees from working for a competitor if the object of the restraint clause is to protect its legitimate interests. What is more, that legitimate interest may only be protected for a reasonable period of time following the termination of the employment relationship.

The court considered that Employsure had a legitimate interest in ensuring that Mr McMurchy’s performance in his role, including during the three-month notice of the termination period, was not affected by an engagement or interest in another business that might hinder or interfere with his performance. Chief among its legitimate interests was the protection of its confidential information. It was necessary, from Employsure’s point of view, to restrain Mr McMurchy from working for ELMO so that its confidential information would be protected from unauthorised disclosure or its misuse in a way that would harm Employsure.

The sensitive information that Mr McMurchy had access to included the marketing, shortcomings and potential development of Employsure’s product. This information was obtained through Mr McMurchy’s senior position with Employsure and his contribution to the development and execution of Employsure’s business strategy and plan. It was information that ELMO could use to the detriment of Employsure.

The court held that the post-employment restraint of nine months was reasonable, considering the length of time Employsure’s confidential information was likely to remain current and of commercial advantage. That nine-month period began from the date Employsure gave the three-month notice of termination, meaning it had effect for six months post-termination.

The court considered that by identifying Mr Kumaran as a potential target for ELMO and by approaching Mr Kumaran about a role with ELMO, Mr McMurchy played a material role in Mr Kumaran’s decision to leave Employsure. The court upheld Sackar’s determination that Mr McMurchy had breached his duty to promote Employsure’s interests and his duty of fidelity and good faith, and his fiduciary duties owed to Employsure. For that reason, Mr McMurchy was liable to compensate for the harm to Employsure caused by Mr Kumaran leaving the company.

The court distinguished this case from situations where one employee had discussed employment opportunities with other potential employers with another employee who had already independently decided to leave his employment.

Because ELMO knowingly assisted or induced Mr McMurchy to breach his fiduciary and contractual duties, it too bore liability for harm caused by Mr Kumaran leaving Employsure.

With regard to Mr Kumaran’s post-employment restraint period, the court held that Employsure also had a legitimate interest in protecting its confidential information. However, the court considered nine months was unreasonable because Mr Kumaran worked in a relatively low-level position (for instance, he had no knowledge of Employsure’s digital marketing strategy) and the retention in his memory of the kind of confidential information he was exposed to (such as customer data, identities and dealings) would necessarily be short-lived. It was not reasonable, therefore, to restrain him from working for a competitor because there was no real risk that confidential information would be misused.

Key takeaways

  • Clauses in employment contracts that aim to restrain employees from working for competitor businesses are only enforceable where the employer can show that the restraints are necessary to protect its legitimate business interests and go no further than is reasonable to protect those interests.
  • Restraint clauses are more likely to be enforceable against senior employees who are privy to commercially sensitive information, but the duration of the restraint will depend on the length of time the information is likely to remain current and of commercial advantage.
  • A senior employee who actively encourages and facilitates another employee to leave his employment may be liable for a breach of fiduciary and contractual duties. A competitor who is knowingly involved in and participates in poaching an employee in this way may bear accessorial liability for the breach of fiduciary and contractual duties.

Authors: Rachel Drew & James Phillips

Disclaimer
The information in this article is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, we do not guarantee that the information in this article is accurate at the date it is received or that it will continue to be accurate in the future.

Published by:

James Phillips

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