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Are Restraints of Trade Legal?

Many people have heard that restraints of trade are not legal and can therefore be ignored. This is incorrect. Restraints of trade are legal providing they are reasonable.

Restraints of trade are contrary to public policy because they compromise a worker’s right to earn a living. The right to work is jealously guarded in employment law and the Employment Court will disregard or reduce restraints of trade that go too far. Essentially the Court balances the employee’s fundamental right to work with the employer’s desire to protect its business from unfair competition.

The Employment Court will weigh up a number of factors to assess whether a restraint of trade is reasonable:

How long is the restraint?

Generally speaking, a restraint of trade up to three months is more likely to be regarded as reasonable. Restraints of 12 months or more are rarely regarded as reasonable.

What area does the restraint cover?

This factor is not as important now as it was before electronic communications allowed a backyard business to compete globally. In appropriate circumstances, however, a restraint of "less than 5 km from the employer's premises" is more likely to be reasonable than "the whole of New Zealand".

In what circumstances is the restraint said to apply?

A restraint of trade clause that applies only when the employee has resigned is more likely to be regarded as reasonable than a restraint that applies no matter what the reason for termination of employment (for example redundancy).

What is the proprietary interest the employer seeks to protect?

If the employer simply seeks to prevent the employee from working for the competition, this is so broad as to likely be unreasonable. On the other hand, if the employee has developed strong relationships with senior managers of the employer’s customers, is a “frontline” contact or has high level knowledge of the arrangements between the employer and its clients, the Employment Court is more likely to agree that the employer is protecting a legitimate proprietary interest.

Sometimes an employer is reluctant, for reasons of commercial sensitivity, to spell out the risks posed by the employee working for a competitor. This reluctance will compromise the employer’s ability to prove that the restraint is reasonable.

Has the employer given sufficient consideration for the restraint?

If the restraint clause is in the employment agreement which the employee signed at the beginning of employment (and the salary is deemed to be sufficient consideration), this is more likely to be regarded as insufficient consideration – particularly if a different employee on a much higher salary is bound by the same restraint.

Is the restraint a “one size fits all” clause?

A business that inserts the same restraint of trade clause in each one of its employment agreements, from the cleaner up to the CEO, risks a finding by the Employment Court that the clause is too wide to be enforceable. The business is required to demonstrate to the Court that it has carefully reduced the scope of the restraint clause to ensure that the restraint is no wider than reasonably necessary in relation to that particular employee.

If the employment agreement also contains a trial clause, the restraint should state to what limited extent it will apply if the employee does not survive the trial. This would demonstrate that the employer is giving particular attention to the effect of the restraint on that particular employee.

What kinds of business is the employee is prevented from doing?

If the restraint says merely that the employee is “restrained from competing against the business of the employer” that is likely to be regarded as too broad and therefore unenforceable. A restraint which describes the prohibited area of business as, for example, “the provision of specialist international fiduciary and trustee services to offshore clients serviced by the employee in the 12 months before their employment ended” is more likely to be regarded as sufficiently and reasonably limited.

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A recent and interesting case: Asiaciti v Harris (December 2013)

The restraint in this case was 12 months long. It prevented the employee from being employed by any business which carried on the business of Asiaciti. Judge Perkins held that the restraint was unreasonable and His Honour declined to amend it – he simply declared it unenforceable.

Lessons to be learned from the Asiaciti case:

Employers have the primary responsibility for getting their restraint clauses right. In addition to making the restraint as limited as is feasible, and as tailored to the individual as possible, the employer should also consider offering, in the restraint clause, an opportunity for the employer to amend the clause upon request by the employee at the time of termination.

Employees have a difficult decision to make when considering signing an employment agreement which contains an onerous restraint clause. Should the employee sign the agreement with a plan to simply treat it as unenforceable if/when the time comes? Or should the employee try to negotiate the clause down and risk (when the employer refuses to budge) looking like the employee has agreed (albeit reluctantly) to the clause. Reluctant agreement is still agreement. This decision has to be made on a case by case basis.

One thing employees can do at the time of their departure, to improve the prospects of reaching a negotiated settlement with the employer, is to be upfront with the employer as soon as possible. Tell your employer you have accepted employment with a competitor. Assure your employer that you are aware of your obligations of confidentiality (and mean it!) and assure your employer that you do not intend to give an unfair competitive advantage to your new employer. In my experience, employers who have been blind-sided (who, for example, find out through the grape vine that their sales rep (upon whom they lavished an extravagant farewell to celebrate his retirement!) is now stealing their clients) tend to want to fight the case through the courts “on principle”.

Moreover, if an employee can show the ERA or Court that they have acted with integrity at the time they handed in their resignation, the Court is more likely to accept the employee’s assertions that they have not or will not disclose or unfairly use the ex-employer’s confidential information.

So, a restraint of trade is lawful if it is reasonable, but no one knows for certain if the restraint is reasonable until a Judge declares it so. The cost of securing that declaration is expensive and time consuming so employers must craft their restraints conservatively and employees must treat them with caution.


For Legal and Strategic Advice on Restraints of Trade, Phone Me for Free Initial Advice

I can offer free initial advice during the day, and after hours, to help you make sense of your situation.

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Further Reading & Downloads

Asiaciti v Harris Judgment