Restraints of trade in Australia for start-ups and SMEs

A really common query we receive at Dexterity Law is whether a restraint of trade clause will be enforceable.  These clauses basically do what they say – restrain or stop a person or company from engaging in a trade or business.  However, whether or not they are enforceable can often be a complex question. That’s why consulting a startup lawyer can help you to navigate this tricky question.

Restraint of trade clauses most commonly appear (and are challenged) in employment agreements.  Business owners, whether start-ups, SMEs or larger organisations, often try to protect their business by restricting the ability of employees to compete with them once they end their employment.  However, this is obviously pretty lousy for healthy competition in commerce, so the Courts will often rule that they’re unenforceable.  In fact, economists have estimated that there is a significant negative impact caused by restraint of trade clauses.  The Federal Trade Commission estimates (here) in the US the cost is between $250 billion and $296 billion per year.

Trade restrictions of all sorts, including restraint of trade clauses, are generally unlawful in Australia unless they are reasonable under all the circumstances. This means that the length and breadth of the restraint must be appropriate for the employer's legitimate business interests. For instance, if the employee had access to sensitive information, a restriction prohibiting them from working in the same industry for a year after leaving their position might be reasonable. However, if the employee's role was purely administrative, the restriction would probably be deemed excessive.

As general guidance, the more power an employee / contractor would have to ‘termite’ your start-up / SME, the more likely you will be able to restrain them from competing.  A good example is where a start-up hires a developer inhouse to build an app – that developer employee gets access to the whole suite of the start-up’s commercial information: strategy, market research, technical information on their software etc…. Given the developer was paid for their employment its then most likely to be reasonable to restrain the developer from going out and building a competitor.  But even in that example any restraint needs a reasonable time limit (e.g. 3 years).

Australian courts have ruled that restraints of trade provisions won't be enforced if they put the employee through an excessive amount of hardship (e.g. interfere with your ability to provide). This means that the provision cannot interfere with the employee's ability to support themselves and cannot be harsher than is necessary to safeguard the employer's legitimate interests.

It's important to note that some restrictions are deemed inappropriate as a starting point, such as those that ban a person from working for a rival for an indeterminate amount of time or from working in their chosen field at all – these are clearly excessive.

The Australian Competition and Consumer Commission (ACCC) and Australian Securities and Investments Commission (ASIC) have the authority to investigate and prosecute violations of the Competition and Consumer Act 2010 (CCA) and the Corporations Act 2001 (Corporations Act), respectively, in addition to the common law prohibitions on restraints of trade and therefore their approaches are important to understand when analysis a clause.

A corporation is prohibited by the CCA from entering into a contract, making an arrangement, or coming to an understanding that substantially lessens competition in some way. This includes contracts that forbid, restrict, or place limits on a person's ability to engage in competitive behaviour (so restraints of trade are risky territory to include in standard form contracts).  In addition, the Corporations Act forbids businesses from entering into certain contracts or agreements that might stop, restrain, or restrict someone from engaging in competitive behaviour.

It is crucial to remember that the CCA and Corporations Act apply to all contracts, including shareholder and partnership agreements, in addition to employment contracts. The ACCC and ASIC have the authority to look into and prosecute violations of the consumer and competition laws. Before incorporating such measures in contracts, it is crucial for both employers and employees to be aware of the legal limitations on restraints of trade clauses. 

Interestingly, in early 2023, the Federal Trade Commission in the USA announced a proposed rule to completely ban restraints of trade in employment agreements, with the following quote taken from their website (which you can access here):

“About one in five American workers—approximately 30 million people—are bound by a non-compete clause and are thus restricted from pursuing better employment opportunities. A non-compete clause is a contractual term between an employer and a worker that blocks the worker from working for a competing employer, or starting a competing business, typically within a certain geographic area and period of time after the worker’s employment ends. Because non-compete clauses prevent workers from leaving jobs and decrease competition for workers, they lower wages for both workers who are subject to them as well as workers who are not. Non-compete clauses also prevent new businesses from forming, stifling entrepreneurship, and prevent novel innovation which would otherwise occur when workers are able to broadly share their ideas.  The Federal Trade Commission proposes preventing employers from entering into non-compete clauses with workers and requiring employers to rescind existing non-compete clauses. The Commission estimates that the proposed rule would increase American workers’ earnings between $250 billion and $296 billion per year. The Commission is asking for the public’s opinion on its proposal to declare that non-compete clauses are an unfair method of competition, and on the possible alternatives to this rule that the Commission has proposed.” (emphasis added).

This won’t affect Australians – but it will be very interesting to see if local legislators pick up on this and seek to bring about a similar rule here.

Dexterity Law is a commercial law firm based in Melbourne’s CBD.  We assist a range of clients on their business needs including advising on restraint of trade clauses.  You can reach out to us here if you’d like to discuss further. We also work online as you can contact use from anywhere.