Are restraints of trade legal?

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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.

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.

If you need advice on restraint of trade clauses, or any other employment agreement issues, call Workplace Law on 09 631 5553.