In late April, the US Federal Trade Commission affected a rule change which imposed a nationwide ban on the use of non-compete clauses in employment contracts. Whilst the US Chamber of Commerce has initiated a challenge to this change, likely delaying the operative effect of any ban, the ban has added fuel to the push by the Australian Government to investigate the use of non-competes and restraint related causes here.
Australian Government's focus on non-compete clauses
In September 2023, the Australian Government released its Employment White Paper Roadmap (Roadmap). The Roadmap noted that despite the uncertainty around their enforceability, non-compete clauses effectively deter employees from switching jobs which in turn inhibits wage growth. This finding sparked a commitment from the Government to investigate the use of non-compete clauses as part of its competition, productivity and wage movement.
One of the first steps in upholding that commitment is the Competition Review's April 2024 Issue Paper which is accepting public and stakeholder submissions until 31 May 2024 to inform the Government about whether reform is needed to control the use of non-compete and restraint related clauses.
In the remainder of this article, we discuss how non-compete and restraint related clauses are applied in Australia and reflect on how the US Federal Trade Commission's recent decision could impact reform in Australia.
What are non-compete and restraint clauses?
On its face, a contractual provision in restraint of trade is void. However, the party seeking to enforce it can do so if the restriction is reasonable by reference to the interests of the parties. This is assessed at the date of the contract. A stricter view is taken of covenants in restraint of trade in employment contracts than those contained in contracts for the sale of a business.
The restraint cannot overreach – it must only go so far as is reasonable to protect the legitimate interests of the party seeking to enforce it.
One such interest is the customer connection or loyalty to a particular employee that arises from repeat dealings between the employee and the customer. This connection gives the employee the capacity to divert the customer's business away from their employer in the event the employee leaves the business. The Courts recognise the employer can deploy a non-solicitation restraint for a reasonable period post-employment so as to give them sufficient 'breathing space'. A reasonable period would enable the employer to break an outgoing employee's customer connection and therefore minimise the ex-employee's capacity to take the customers with them.
Non-solicitation clauses can also be deployed to restrict ex-employees from poaching employees, suppliers or referrers of work.
Another common restraint clause is a non-compete clause, which can be used in employment contracts to restrain ex-employees from establishing or being engaged by a competing business, whether that be by means of employment, contracted work or ownership. Given the scope of non-compete restraints, which will have a significantly greater impact on the ex-employee, the Courts will generally require a higher standard for the employer to justify its reasonableness.
Aside from the question of reasonableness, a restraint of trade covenant will need to be well drafted so that there is no uncertainty about its operation. This will require the clause to clearly outline:
- the activity to be covered
- a reasonable geographical location for restraint
- a reasonable time period for restraint.
A recent example of how courts interpret restraint clauses
In the recent case of Lochdyl Pty Ltd v Lind [2024] SAMC 43, the Magistrates Court of South Australia considered the enforceability of a restraint clause on a hairdresser who had left her prior salon to start her own business. The hairdresser's employment contract had a restraint that sought to prevent her from diverting or attempting to divert any business from her former employer, soliciting or attempting to solicit its customers for a two-year period after the employment relationship ended.
It was alleged that the former employee had breached this restraint clause by posting on social media about her new business venture, tagging her former employee and thanking her "wonderful clients who have stayed with her". In response, her former employer sought $85,000 in damages.
Whilst the Court determined that the hairdressing business had a legitimate business interest in restraining its former employee, a two-year restraint was not "reasonably necessary" to protect those interests. In coming to that conclusion, the Court looked at the behaviour patterns of hairdressing customers generally, the behaviour of the specific clientele of that salon and the level of pay the former employee received.
Specifically, the Court considered:
- that the employer had recently bought the business from the employee's mother and sister and that it had paid valuable consideration for goodwill of the existing customer base
- the employee had worked at the salon for 12 years and had developed personal connections with a large number of those existing customers
- repeat customers often booked appointments into the future to secure the availability of a particular hairdresser or service
- often, a customer would book an appointment with two hairdressers to perform different services at the same time, or even a different hairdresser if their preferred hairdresser was unavailable
- it would take a hairdresser one or two appointments to establish a connection with a customer
- the employee was a casual employee who was paid an hourly rate that was only slightly higher than the minimum rate under the applicable modern award.
These factors when viewed together, did not support a two year restraint and as such, the clause was deemed void and unenforceable against the former employee. The business only needed around three months 'breathing space' to break an outgoing employee's customer connection and undermine their ability to influence customers to leave.
Takeaways
This case serves as a reminder that a restraint needs to be reasonable in the circumstances otherwise any claim to enforce the restraint may be dismissed and the restraint deemed unenforceable. This decision, in addition to the US' ban, will arguably bolster the Australian Government's push to regulate post-employment restraints in Australia and limit their use in the employment contracts of low-income workers.
This will continue to be a topical issue as submissions for the Competition Review's Issue Paper close. We will share updates on the next steps when the findings are released.
This publication does not deal with every important topic or change in law and is not intended to be relied upon as a substitute for legal or other advice that may be relevant to the reader's specific circumstances. If you have found this publication of interest and would like to know more or wish to obtain legal advice relevant to your circumstances please contact one of the named individuals listed.