How Do Non-Compete Clauses Work?
A non-compete clause, also known as a restraint of trade clause, is a clause which protects businesses from having a party compete or work against them. Such a clause exists to prevent unfair competition from occurring. Upon the inclusion of this clause, the use of both confidential and general information that could be used against a business that a party is no longer in a contractual agreement with is prohibited. Non-compete clauses are found in a majority of business contracts, including:
- Employment agreements
- Used in this context, they prevent an ex-employee from working for rivals, starting a business in the same space, and exploiting information (eg. trade secrets, client lists) which would give unfair advantage.
- Sales of Business agreements
- This is designed to prevent the seller from opening a business in the same field for a particular time frame.
- Franchise agreements
- Restrains the franchisee from setting up a competing business in the same location.
Types of Restricted or Competitive Activities
The restraints covered by a non compete clause can be categorised into three main categories:
- Non-compete: This clause stops one party from competing with another.
Eg. A seller cannot open a business or work for one in the same industry or location within a particular time frame
- Non-solicitation: This clause stops one party from engaging with and luring/soliciting other parties that have a relation with the business
Eg. The seller cannot approach individuals such as employees, clients or suppliers
- Recruitment: This clause stops a party from engaging with and luring/soliciting people who have a high position within the business
Eg. Managers, senior employees
Enforcing a Non-Compete Clause
Non-compete clauses are only enforced in Australia if they are seen to be reasonably necessary to protect the goodwill of the business that benefits from this clause. It is the responsibility of the party looking to enforce the non-compete to prove that the non-compete protects a genuine interest that can be valued.
When it comes to considering what is reasonable and as a result enforceable, the court considers key factors which include:
- The area: Refers to the geographic area that the non compete is applicable.
Eg.How close is the distance of the competing business that an ex-employee is now employed by, how close is the business that the seller is opening to the business?
- Time: How long is the time frame that a seller may not open up a competing business, be employed by a competing business or solicit with customers of the business being sold?
Eg. This can be a few years, few months, weeks
- Act: What activities does the non compete seek to restrain and prevent?
Eg. Does the non complete only seek to prevent former employees from soliciting with current employees? Or does it also prevent former employees from recruiting clients from the business they were formerly employed by?
- Protection of commercial interests: Does the non compete seek to protect a genuine interest that can be seen with high regard by the courts?
- Eg. Interests with high value may include goodwill, intellectual property and trade secrets
Application of the Non-compete Clause
- The court balances both the goodwill and interests of the party seeking to enforce the non compete clause with the restrictions that the non compete clause presents.
- If the non compete clause that is trying to be enforced by a party is unreasonable, the court can remove sections that are perceived to be unreasonable
A non compete clause is a vital provision for a contract as it helps businesses preserve the goodwill of their business. Upon drafting a non compete clause, it is important that the clause is drafted to be as reasonable as possible. This is because a court will look to balance the interests of the party enforcing the non compete alongside with the restrictions, leading to a potential severance of parts which are considered unreasonable by the courts.
If you need assistance drafting a non compete clause, get in touch with us at 1300 337 997.