Non-compete clauses face increasing scrutiny amid calls for reform


Non-compete clauses are in the spotlight following significant legal developments in Australia and abroad. Could it be the time of reckoning for these restraints?

Non-com­pete claus­es are currently under scrutiny from var­i­ous quarters.

Broad­ly speak­ing, non-com­pete claus­es are a form of post-employ­ment restraint that pro­hib­it an employ­ee from work­ing for a com­peti­tor of their pre­vi­ous employ­er for a spec­i­fied peri­od in a defined geo­graph­ic area.

The ratio­nale for non-com­pete claus­es being imposed on depart­ing employ­ees is to pro­tect the legit­i­mate busi­ness inter­ests of the for­mer employ­er, usu­al­ly con­fi­den­tial infor­ma­tion and cus­tomer rela­tion­ships. This pro­tec­tion, how­ev­er, needs to be bal­anced against the right and need of the for­mer employ­ee to ply their trade or pro­fes­sion and earn a liv­ing. 

This bal­ance is why there is a ques­tion as to the enforce­abil­i­ty of non-com­pete restraints, with courts called upon to adju­di­cate as to whether a non-com­pete restraint should be enforced against a for­mer employ­ee and, if so, to what extent (in terms of time peri­od and geo­graph­ic scope). 

A court will not enforce the restraint beyond what is rea­son­ably nec­es­sary to pro­tect the legit­i­mate busi­ness inter­ests of the for­mer employ­er seek­ing to rely upon it. As a rule of thumb, it’s usually senior employ­ees who have sig­nif­i­cant access to con­fi­den­tial infor­ma­tion and cus­tomer rela­tion­ships who may have their non-compete clauses enforced. 

As such, there can be a prop­er basis for impos­ing a non-com­pete restraint against such employ­ees, as they can dam­age the busi­ness inter­ests of the for­mer employ­er by mov­ing to a com­peti­tor. There is a real prospect a court will enforce a non-com­pete in such circumstances.

However, there is an increas­ing­ly influ­en­tial view that it may be unfair for employ­ers to impose restraints on rel­a­tive­ly junior or low­er-lev­el employ­ees who have not had access to con­fi­den­tial infor­ma­tion or cus­tomer rela­tion­ships.This unjus­ti­fi­ably keeps those employ­ees from oppor­tu­ni­ties with oth­er employ­ers, and impedes labour mar­ket mobil­i­ty. In these cir­cum­stances, a court would like­ly give any attempt by an employ­er to enforce such a restraint against a for­mer employ­ee short shrift.

Unfair dismissal case brings non-compete clause into question 

In a recent unfair dis­missal deci­sion, the Fair Work Com­mis­sion con­sid­ered the impact of a non-com­pete clause imposed on an appli­cant on his oblig­a­tion to mit­i­gate the loss from his dismissal. 

The appli­cant in this case was a sales­per­son sell­ing grout­ing and grout­ing ser­vices. The FWC addressed the issue of the non-com­pete clause and its rel­e­vance to mit­i­ga­tion of loss.

Deputy Pres­i­dent Col­man, by way of back­ground, observed:

“Sec­tion 392(2)(d) requires the Com­mis­sion to con­sid­er the efforts of the per­son to mit­i­gate the loss suf­fered as a result of the dis­missal. [the applicant] said that he had applied for hun­dreds of jobs on ​‘Seek’, includ­ing sales jobs, in which he had a lot of expe­ri­ence. How­ev­er, he said that he had not applied for jobs in the same sec­tor as his pre­vi­ous work, because of the pres­ence of a post-employ­ment restraint pro­vi­sion in his con­tract of employ­ment (clause 10.1). 

“This stat­ed that for a peri­od of 12 months after the ter­mi­na­tion of his con­tract of employ­ment, [he] was not to work as an employ­ee or con­trac­tor or advi­sor or in any oth­er capac­i­ty in any busi­ness which was ​‘engaged in activ­i­ties sub­stan­tial­ly sim­i­lar or iden­ti­cal to the Com­pa­ny and pro­vides ser­vices sub­stan­tial­ly sim­i­lar or ser­vices offered by the Company.’”

Deputy Pres­i­dent Col­man then pro­vid­ed com­men­tary on the restraint, rel­e­vant to the appli­cant but also of inter­est more broad­ly on the issue of post-employ­ment restraints imposed on ​‘ordi­nary’ workers:

“One won­ders why such restraint of trade pro­vi­sions are so com­mon­ly found in the con­tracts of ordi­nary work­ers and whether they real­ly pro­tect any legit­i­mate busi­ness inter­est of the employ­er, or mere­ly serve to fet­ter the abil­i­ty of work­ers to ply their trade, and to reduce com­pe­ti­tion for labour and ser­vices.

Ordi­nar­i­ly, one would expect a per­son to have applied for jobs in the sec­tor of their exper­tise as a rea­son­able step in mit­i­gat­ing loss. How the pres­ence of a non-com­pete pro­vi­sion in his con­tract explains [the applicant’s] deci­sion not to do so.

“A court will not enforce the restraint beyond what is rea­son­ably nec­es­sary to pro­tect the legit­i­mate busi­ness inter­ests of the for­mer employ­er.”

Although the pro­vi­sion is most like­ly unen­force­able on the basis that its scope is unrea­son­able, an ordi­nary work­er can­not be expect­ed to know this, and it is under­stand­able that [the applicant] would not want to risk embroil­ing him­self in a legal con­tro­ver­sy by act­ing con­trary to an express pro­vi­sion in his con­tract.”

As a result, the FWC refused to reduce the amount of compensation awarded to the applicant for unfair dismissal.

This decision highlights the disconnect between legal principles for non-compete clauses and how many employers enforce these restrictions on employees, regardless of whether they had enough access to confidential information or customer relationships to justify the restrictions.

This sit­u­a­tion often aris­es from employ­ers using pro for­ma employ­ment agree­ments which con­tain, as part of their stan­dard terms, post-employ­ment restraints such as non-com­pete and non-solic­it claus­es. 

Often lit­tle thought or con­sid­er­a­tion is giv­en to whether to include the post-employ­ment restraints or to their ulti­mate enforce­abil­i­ty if test­ed. Indeed, there may be no inten­tion on the part of the employ­er to ever enforce the restraints. 

Of course, employ­ees are not to know this – as far as they are con­cerned there is a post-employ­ment restraint in their con­tract and, as Deputy Pres­i­dent Col­man observed, they may not want to be poten­tial­ly drawn into a legal dis­pute with a for­mer employ­er and so com­ply with the restraint, even if the employ­er had no inten­tion of enforc­ing it. 

Reviews of non-competes in the USA and Australia

This deci­sion comes at a time when post-employ­ment restraints are under review, both in Aus­tralia and the USA. 

In the USA, the Fed­er­al Trade Com­mis­sion (FTC) has tak­en the dras­tic step of ban­ning non-com­pete claus­es in employ­ment con­tracts com­plete­ly. 

Only exist­ing non-com­pete claus­es for senior exec­u­tives (a cohort of less than 0.75 per cent of work­ers in the US) will con­tin­ue to be enforce­able. Moving forward, there can be no new non-com­pete restraints for any employ­ees, includ­ing senior executives. 

In Aus­tralia, the Com­pe­ti­tion Review Task­force is present­ly exam­in­ing non-com­pete claus­es and var­i­ous oth­er form of employ­ment restraints, with sub­mis­sions being sought. 

The Issues Paper released by the Com­pe­ti­tion Review Task­force pro­vides this summary:

“Sev­er­al issues have been iden­ti­fied relat­ing to the use and impact of non-com­pete claus­es. Many issues iden­ti­fied in empir­i­cal analy­sis have been affirmed as prac­ti­cal issues affect­ing Aus­tralia today through the Com­pe­ti­tion Review Taskforce’s ear­ly engage­ment, and include con­cerns about:

  • The ​“chill­ing effect” of restraint claus­es on work­er mobil­i­ty, par­tic­u­lar­ly among low­er-income work­ers, to choose bet­ter-pay­ing jobs, and the abil­i­ty for busi­ness­es to start up, recruit tal­ent and grow.
  • The high cost of lit­i­ga­tion, the lack of clear guid­ance and ​‘bright line’ rules, and the use of cas­cad­ing claus­es or the ​‘blue pen­cil test’, which can leave both work­ers and busi­ness­es with an unclear under­stand­ing whether an agreed restraint will be upheld as rea­son­able and enforce­able.
  • The eco­nom­ic con­se­quences of poten­tial­ly inef­fi­cient allo­ca­tion of labour and infor­ma­tion, which may be ham­per­ing pro­duc­tiv­i­ty growth and innovation.”

These are rea­son­able con­cerns, but they can be addressed with­out ban­ning non-com­pete claus­es alto­geth­er. 

In deter­min­ing the enforce­abil­i­ty of such restraints, the courts, through prin­ci­ples devel­oped over decades of judi­cial con­sid­er­a­tion, care­ful­ly endeav­our to ensure an appro­pri­ate bal­ance is struck between the right of employ­ers to pro­tect their legit­i­mate busi­ness inter­ests and the right of employ­ees to change posi­tions and earn a liv­ing. 

Do you think non-compete clauses should be banned? Let us know in the comment section.

Michael Byrnes is a Partner at Swaab. A version of this article first appeared on Swaab’s website. You can view the original here.


Need help brushing up on HR laws and compliance? AHRI’s short course will give you an understanding of the key elements of legislation, regulation and practices HR needs to be across.


 

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Kathlee
Kathlee
19 days ago

For many years as an HR professional the topic of restraint clauses invariably comes up. My position on this is to apply fairness and what is reasonable. I think Restraint Clauses have a part to play but you must consider the particular circumstances for the exiting individual and the business equally. I agree that for lower level employees that have little or no access to confidential information or influence over customers the restraints are not worth having. The onus is on the business to protect their IP and relationships over the duration of employment and beyond and not rely on… Read more »

Bree Yardley
Bree Yardley
19 days ago

Banning non-compete clauses outright defeats the purpose of why they were introduced in the first place – to protect the legitimate interests of a company. However, their introduction into less-than-senior role contracts where the employee has no access to confidential information and does not create close customer relationships is troublesome, and my advice to employers was always that they were likely to be unenforceable, based on the reasoning that everyone is entitled to earn a living. I had never considered that employees would feel themselves bound by the clauses, or that they might affect the outcomes of a Fair Work… Read more »

More on HRM
Sorry, no posts matched your criteria.

Non-compete clauses face increasing scrutiny amid calls for reform


Non-compete clauses are in the spotlight following significant legal developments in Australia and abroad. Could it be the time of reckoning for these restraints?

Non-com­pete claus­es are currently under scrutiny from var­i­ous quarters.

Broad­ly speak­ing, non-com­pete claus­es are a form of post-employ­ment restraint that pro­hib­it an employ­ee from work­ing for a com­peti­tor of their pre­vi­ous employ­er for a spec­i­fied peri­od in a defined geo­graph­ic area.

The ratio­nale for non-com­pete claus­es being imposed on depart­ing employ­ees is to pro­tect the legit­i­mate busi­ness inter­ests of the for­mer employ­er, usu­al­ly con­fi­den­tial infor­ma­tion and cus­tomer rela­tion­ships. This pro­tec­tion, how­ev­er, needs to be bal­anced against the right and need of the for­mer employ­ee to ply their trade or pro­fes­sion and earn a liv­ing. 

This bal­ance is why there is a ques­tion as to the enforce­abil­i­ty of non-com­pete restraints, with courts called upon to adju­di­cate as to whether a non-com­pete restraint should be enforced against a for­mer employ­ee and, if so, to what extent (in terms of time peri­od and geo­graph­ic scope). 

A court will not enforce the restraint beyond what is rea­son­ably nec­es­sary to pro­tect the legit­i­mate busi­ness inter­ests of the for­mer employ­er seek­ing to rely upon it. As a rule of thumb, it’s usually senior employ­ees who have sig­nif­i­cant access to con­fi­den­tial infor­ma­tion and cus­tomer rela­tion­ships who may have their non-compete clauses enforced. 

As such, there can be a prop­er basis for impos­ing a non-com­pete restraint against such employ­ees, as they can dam­age the busi­ness inter­ests of the for­mer employ­er by mov­ing to a com­peti­tor. There is a real prospect a court will enforce a non-com­pete in such circumstances.

However, there is an increas­ing­ly influ­en­tial view that it may be unfair for employ­ers to impose restraints on rel­a­tive­ly junior or low­er-lev­el employ­ees who have not had access to con­fi­den­tial infor­ma­tion or cus­tomer rela­tion­ships.This unjus­ti­fi­ably keeps those employ­ees from oppor­tu­ni­ties with oth­er employ­ers, and impedes labour mar­ket mobil­i­ty. In these cir­cum­stances, a court would like­ly give any attempt by an employ­er to enforce such a restraint against a for­mer employ­ee short shrift.

Unfair dismissal case brings non-compete clause into question 

In a recent unfair dis­missal deci­sion, the Fair Work Com­mis­sion con­sid­ered the impact of a non-com­pete clause imposed on an appli­cant on his oblig­a­tion to mit­i­gate the loss from his dismissal. 

The appli­cant in this case was a sales­per­son sell­ing grout­ing and grout­ing ser­vices. The FWC addressed the issue of the non-com­pete clause and its rel­e­vance to mit­i­ga­tion of loss.

Deputy Pres­i­dent Col­man, by way of back­ground, observed:

“Sec­tion 392(2)(d) requires the Com­mis­sion to con­sid­er the efforts of the per­son to mit­i­gate the loss suf­fered as a result of the dis­missal. [the applicant] said that he had applied for hun­dreds of jobs on ​‘Seek’, includ­ing sales jobs, in which he had a lot of expe­ri­ence. How­ev­er, he said that he had not applied for jobs in the same sec­tor as his pre­vi­ous work, because of the pres­ence of a post-employ­ment restraint pro­vi­sion in his con­tract of employ­ment (clause 10.1). 

“This stat­ed that for a peri­od of 12 months after the ter­mi­na­tion of his con­tract of employ­ment, [he] was not to work as an employ­ee or con­trac­tor or advi­sor or in any oth­er capac­i­ty in any busi­ness which was ​‘engaged in activ­i­ties sub­stan­tial­ly sim­i­lar or iden­ti­cal to the Com­pa­ny and pro­vides ser­vices sub­stan­tial­ly sim­i­lar or ser­vices offered by the Company.’”

Deputy Pres­i­dent Col­man then pro­vid­ed com­men­tary on the restraint, rel­e­vant to the appli­cant but also of inter­est more broad­ly on the issue of post-employ­ment restraints imposed on ​‘ordi­nary’ workers:

“One won­ders why such restraint of trade pro­vi­sions are so com­mon­ly found in the con­tracts of ordi­nary work­ers and whether they real­ly pro­tect any legit­i­mate busi­ness inter­est of the employ­er, or mere­ly serve to fet­ter the abil­i­ty of work­ers to ply their trade, and to reduce com­pe­ti­tion for labour and ser­vices.

Ordi­nar­i­ly, one would expect a per­son to have applied for jobs in the sec­tor of their exper­tise as a rea­son­able step in mit­i­gat­ing loss. How the pres­ence of a non-com­pete pro­vi­sion in his con­tract explains [the applicant’s] deci­sion not to do so.

“A court will not enforce the restraint beyond what is rea­son­ably nec­es­sary to pro­tect the legit­i­mate busi­ness inter­ests of the for­mer employ­er.”

Although the pro­vi­sion is most like­ly unen­force­able on the basis that its scope is unrea­son­able, an ordi­nary work­er can­not be expect­ed to know this, and it is under­stand­able that [the applicant] would not want to risk embroil­ing him­self in a legal con­tro­ver­sy by act­ing con­trary to an express pro­vi­sion in his con­tract.”

As a result, the FWC refused to reduce the amount of compensation awarded to the applicant for unfair dismissal.

This decision highlights the disconnect between legal principles for non-compete clauses and how many employers enforce these restrictions on employees, regardless of whether they had enough access to confidential information or customer relationships to justify the restrictions.

This sit­u­a­tion often aris­es from employ­ers using pro for­ma employ­ment agree­ments which con­tain, as part of their stan­dard terms, post-employ­ment restraints such as non-com­pete and non-solic­it claus­es. 

Often lit­tle thought or con­sid­er­a­tion is giv­en to whether to include the post-employ­ment restraints or to their ulti­mate enforce­abil­i­ty if test­ed. Indeed, there may be no inten­tion on the part of the employ­er to ever enforce the restraints. 

Of course, employ­ees are not to know this – as far as they are con­cerned there is a post-employ­ment restraint in their con­tract and, as Deputy Pres­i­dent Col­man observed, they may not want to be poten­tial­ly drawn into a legal dis­pute with a for­mer employ­er and so com­ply with the restraint, even if the employ­er had no inten­tion of enforc­ing it. 

Reviews of non-competes in the USA and Australia

This deci­sion comes at a time when post-employ­ment restraints are under review, both in Aus­tralia and the USA. 

In the USA, the Fed­er­al Trade Com­mis­sion (FTC) has tak­en the dras­tic step of ban­ning non-com­pete claus­es in employ­ment con­tracts com­plete­ly. 

Only exist­ing non-com­pete claus­es for senior exec­u­tives (a cohort of less than 0.75 per cent of work­ers in the US) will con­tin­ue to be enforce­able. Moving forward, there can be no new non-com­pete restraints for any employ­ees, includ­ing senior executives. 

In Aus­tralia, the Com­pe­ti­tion Review Task­force is present­ly exam­in­ing non-com­pete claus­es and var­i­ous oth­er form of employ­ment restraints, with sub­mis­sions being sought. 

The Issues Paper released by the Com­pe­ti­tion Review Task­force pro­vides this summary:

“Sev­er­al issues have been iden­ti­fied relat­ing to the use and impact of non-com­pete claus­es. Many issues iden­ti­fied in empir­i­cal analy­sis have been affirmed as prac­ti­cal issues affect­ing Aus­tralia today through the Com­pe­ti­tion Review Taskforce’s ear­ly engage­ment, and include con­cerns about:

  • The ​“chill­ing effect” of restraint claus­es on work­er mobil­i­ty, par­tic­u­lar­ly among low­er-income work­ers, to choose bet­ter-pay­ing jobs, and the abil­i­ty for busi­ness­es to start up, recruit tal­ent and grow.
  • The high cost of lit­i­ga­tion, the lack of clear guid­ance and ​‘bright line’ rules, and the use of cas­cad­ing claus­es or the ​‘blue pen­cil test’, which can leave both work­ers and busi­ness­es with an unclear under­stand­ing whether an agreed restraint will be upheld as rea­son­able and enforce­able.
  • The eco­nom­ic con­se­quences of poten­tial­ly inef­fi­cient allo­ca­tion of labour and infor­ma­tion, which may be ham­per­ing pro­duc­tiv­i­ty growth and innovation.”

These are rea­son­able con­cerns, but they can be addressed with­out ban­ning non-com­pete claus­es alto­geth­er. 

In deter­min­ing the enforce­abil­i­ty of such restraints, the courts, through prin­ci­ples devel­oped over decades of judi­cial con­sid­er­a­tion, care­ful­ly endeav­our to ensure an appro­pri­ate bal­ance is struck between the right of employ­ers to pro­tect their legit­i­mate busi­ness inter­ests and the right of employ­ees to change posi­tions and earn a liv­ing. 

Do you think non-compete clauses should be banned? Let us know in the comment section.

Michael Byrnes is a Partner at Swaab. A version of this article first appeared on Swaab’s website. You can view the original here.


Need help brushing up on HR laws and compliance? AHRI’s short course will give you an understanding of the key elements of legislation, regulation and practices HR needs to be across.


 

Subscribe to receive comments
Notify me of
guest

2 Comments
Inline Feedbacks
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Kathlee
Kathlee
19 days ago

For many years as an HR professional the topic of restraint clauses invariably comes up. My position on this is to apply fairness and what is reasonable. I think Restraint Clauses have a part to play but you must consider the particular circumstances for the exiting individual and the business equally. I agree that for lower level employees that have little or no access to confidential information or influence over customers the restraints are not worth having. The onus is on the business to protect their IP and relationships over the duration of employment and beyond and not rely on… Read more »

Bree Yardley
Bree Yardley
19 days ago

Banning non-compete clauses outright defeats the purpose of why they were introduced in the first place – to protect the legitimate interests of a company. However, their introduction into less-than-senior role contracts where the employee has no access to confidential information and does not create close customer relationships is troublesome, and my advice to employers was always that they were likely to be unenforceable, based on the reasoning that everyone is entitled to earn a living. I had never considered that employees would feel themselves bound by the clauses, or that they might affect the outcomes of a Fair Work… Read more »

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