How do courts enforce restraint of trade clauses?

In Brief

Fol­low­ing on from our ear­li­er arti­cle regard­ing Pre­serv­ing your busi­ness through restraint of trade claus­es, the New South Wales Supreme Court has recent­ly hand­ed down a deci­sion which pro­vides valu­able insight into the approach that the judi­cia­ry takes to enforc­ing restraint of trade clauses.

Sev­en Net­work (Oper­a­tions) Ltd 7 ors v James War­bur­ton (No 2) [2011] NSWSC 386

James War­bur­ton, a high­ly skilled and tal­ent­ed tele­vi­sion exec­u­tive, was employed by the Sev­en Net­work [Sev­en] as the Chief Sales & Dig­i­tal Offi­cer under a fixed term con­tract due to expire on 14 Octo­ber 2011.

Mr War­bur­ton was con­sid­ered the nat­ur­al suc­ces­sor as Chief Exec­u­tive Offi­cer of Sev­en but seized an oppor­tu­ni­ty to become the Chief Exec­u­tive Offi­cer at Net­work 10 with a com­mence­ment date of 14 July 2011. Hav­ing accept­ed this offer on 2 March 2011 and com­mu­ni­cat­ed the sit­u­a­tion to Sev­en, they react­ed by requir­ing Mr War­bur­ton to leave their premis­es and sought to enforce a restraint of trade clause, which pre­vent­ed him from work­ing for Net­work 10 for a peri­od of 12 months from the date that he ​“ceas­es to be employed or engaged” by Seven.

First Issue – When Does the Restraint Peri­od Begin Operation?

The first issue which was con­sid­ered, con­cerned the date when the restraint peri­od commenced.

Sev­en assert­ed that the twelve month restraint peri­od should com­mence from the expiry of the fixed term con­tract on 14 Octo­ber 2011. Con­verse­ly, Mr War­bur­ton argued that if the restraint was valid, the restraint peri­od should start from 2 March 2011, being the date that Sev­en required him to leave their premis­es and refrain from per­form­ing all duties.

Jus­tice Pem­broke of the NSW Supreme Court rea­soned that if he approved the Sev­en’s argu­ment, it would mean that the restraint would oper­ate for a peri­od of 19 months, being the peri­od of 12 months from the expiry of the con­tract on 14 Octo­ber 2011, rather than the intend­ed 12 months. Giv­en that Mr War­bur­ton had been placed on ​“gar­den­ing leave” (i.e. a peri­od where the employ­ee is sent home and not required to per­form work dur­ing the notice peri­od) by Sev­en, this would lead to an unrea­son­able result because he had no access to con­fi­den­tial infor­ma­tion or the clients of Sev­en from this date.

Accord­ing­ly, his Hon­our found in favour of Mr War­bur­ton on this point by hold­ing that as he had ceased employ­ment in a prac­ti­cal sense from the date he was placed on gar­den­ing leave, and as the par­ties intend­ed the restraint peri­od to oper­ate for 12 months, the restraint peri­od start­ed from the date he was placed on gar­den­ing leave, being 2 March 2011.

Sec­ond Issue – Is the Restraint of Trade Clause Valid?

One of the key issues con­sid­ered in a mat­ter con­cern­ing a restraint of trade clause, is, whether it is in fact valid and enforce­able. The cen­tral prin­ci­ple which gov­erns this exer­cise is that a restraint will not be enforced unless it is nec­es­sary for the rea­son­able pro­tec­tion of the employ­er’s legit­i­mate interests.

In this deci­sion, his Hon­our ini­tial­ly sought to ascer­tain whether the restraint was rea­son­able at the time it was agreed between the par­ties. His Hon­our found that it was rea­son­able hav­ing regard to the fol­low­ing factors:

1. The restraint derived from an equi­ty par­tic­i­pa­tion deed entered into between man­age­r­i­al employ­ees and Sev­en. The object of this restraint was to reduce the risk of deval­u­a­tion of the busi­ness by the depar­ture of any exec­u­tives to com­peti­tors; to reduce the risk of the mis­use of con­fi­den­tial infor­ma­tion by com­peti­tors; and to reduce the risk of dis­si­pa­tion in the cus­tomer con­nec­tion of the business.
2. Mr War­bur­ton acknowl­edged the rea­son­able­ness of the restraint by sign­ing the equi­ty par­tic­i­pa­tion deed and was well aware of the effect of the restraint as he had received inde­pen­dent legal advice.
3. The major­i­ty of the Sev­en’s adver­tis­ing rev­enue is gen­er­at­ed from five agency buy­ing groups. The con­tracts for four of those agency buy­ing groups are nego­ti­at­ed on an annu­al basis com­menc­ing in Sep­tem­ber and con­clud­ing in November/​December. Mr War­bur­ton had access to the con­fi­den­tial infor­ma­tion used in nego­ti­at­ing these con­tracts, name­ly the dif­fer­en­tial rates and trad­ing terms entered with the agency buy­ing groups. This twelve month busi­ness cycle explained the com­mer­cial rea­son behind select­ing a 12 month restraint period.

After con­clud­ing that the restraint was rea­son­able, his Hon­our observed that it is an entire­ly dif­fer­ent ques­tion as to whether it will be enforced for the entire restraint peri­od. Fur­ther, his Hon­our ordered that the restraint be enforced only until 1 Jan­u­ary 2012 because of the fol­low­ing factors:

1. Dur­ing the peri­od between March and 31 Decem­ber 2011, Sev­en can be expect­ed to finalise the con­tracts with four of the five agency buy­ing groups and, hence, Mr War­bur­ton will no longer have knowl­edge of these con­tracts when he com­mences nego­ti­at­ing with these agency buy­ing groups on behalf of Net­work 10 in 2012.
2. There is no real­is­tic con­cern regard­ing cus­tomer con­nec­tion because this is not an indus­try where senior exec­u­tives ​“car­ry their employ­er’s cus­tomers in their back pocket”.
3. Although it may appear unusu­al that his Hon­our refused to enforce a con­trac­tu­al term which was found to be rea­son­able, the under­ly­ing prin­ci­ple must be remem­bered that a restraint will only be enforced to the extent that it pro­tects the employ­er’s legit­i­mate interests.

Lessons for Employers

Employ­ers need to be aware that if they choose to place an employ­ee on gar­den­ing leave, it may (depend­ing on the terms of the restraint clause) and sur­round­ing cir­cum­stances, be tak­en into account by the court in deter­min­ing the appro­pri­ate­ness of any restraint peri­od. Sec­ond­ly, employ­ers must under­stand that although they have agreed to a restraint with an employ­ee, it does not nec­es­sar­i­ly fol­low that a court will enforce it to its full effect, because a restraint will only be enforced to the extent that it is nec­es­sary to pro­tect the employ­er’s legit­i­mate interests.

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