In Australia, non-compete clause is commonly found in employment contracts for professional and senior employees to prevent departing employees from working for a competitor and protect the employer’s legitimate interests. Recently, the application of cascading clauses becomes the norm for restraint clauses in Australia. It is crucial for the employers to have a clear understanding of what is fair and legal when they adopt a non-compete clause in the employment contract.
What is a cascading clause?
A clause which provides different levels of restraints in an employment contract is often called a cascading clause. Cascading clauses can operate by providing alternative options in regard to distance, geographical areas, time periods and the type of conduct to be restricted. These clauses are also called ladder clauses and step clauses.
The validity of cascading clauses was discussed in the case of OAMPS Insurance Brokers Ltd v Hanna by the New South Wales Supreme Court. Mr Hanna worked for OAMPS Insurance Brokers Ltd for 19 years as a Client Director of the Consulting department. There is no doubt that entering into an employment relationship with another insurance company after Mr Hanna’s resignation seriously affected the relationship between OAMPS and its clients. As the cascading restraint clauses in this case stipulated:
1. To reasonably protect the goodwill and legitimate business interests of the Company, during the Restraint Period and within the Restraint Area (referred to below), you will not, without prior written consent the Company, directly or indirectly:
a) Entice or solicit, or assist another person to entice or solicit, an employee, contractor, officer, agent or supplier of the Company with whom you have had dealings prior to your employment ending, to cease to provide services to the Company;
b) Canvass, solicit or deal with, or counsel, procure or assist another person to canvass, solicit or deal with any client of the Company with whom you have had dealings during the two-year period prior to your employment ending.
2. Restraint period means, from the date of termination of your employment:
(a) 15 months;
(b) 13 months;
(c) 12 months.
Restraint Area means:
(b) The State or Territory in which you are employed at the date of termination of your employment;
(c) The metropolitan area of the capital city in which you are employed at the date of termination of your employment.……
4. Each restraint contained in this Deed (resulting from any combination of the wording in clauses 1 and 2) constitutes a separate and independent provision, severable from the other restraints. If a court of competent jurisdiction finally decides any such restraint to be unenforceable or whole or in part, the enforceability of the remainder of that restraint and any other restraint will not be affected.
The NSW Court of Appeal ultimately confirmed the validity of cascading restraint clauses in employment contracts and enforced the post-employment restraint covenant for 12 months throughout Australia.
How does the court interpret the cascading clause?
The court will strictly review the validity of the clause, taking into account the specific circumstances of each case. In the case of OAMPS Insurance Brokers Ltd v Hanna, Mr Hanna claimed that the restraint clause was void due to its uncertainty of the scope. However, the Justice found the clauses reasonable and enforceable.
The essence of the restraint covenants is clause 4, which clearly stipulated that the relevant provisions are separate and independent. The Justice pointed out that there are 9 different restraints which are clear, reasonable and binding, varying from 15 months to 12 months across Australia and the metropolitan area of Sydney. As a result, Mr Hanna was restrained from dealing with clients in a specified list for a period of 12 months and the court held that it was reasonable and necessary to protect OAMP’s legitimate interests.
Unlike traditional non-compete clauses, if an ex-employee is deemed to have breached the restrictive covenants, the employer can apply to the Court to enforce the cascading clause and then the Court will determine which level in the cascading clauses is applicable to the employee. If the court considers 12 months is too long to protect the employer, then that clause will be severed from the agreement and the alternative level will be applied. The use of cascading clauses is much more flexible. It is really important for the court to seek a balance between employer’s business interests and employee’s right. There is no doubt that each case will be assessed individually. Generally, the more experienced and senior the employee is, the more extensive the restraint will be.
What the employers should pay attention to?
1. Carefully drafted cascading clauses need to be included in the restraint clauses.
Employers should carefully apply the cascading clauses and maintain higher levels of flexibility and independence of the clauses. In the case of Wallis Nominees (Computing) Pty Ltd v Pickett the Justice held that Pickett, as an IT consultant with Walis Nominees (DWS) should not be restrained from starting employment relationship with DWS’ clients and the 12-month restraint period was unreasonable. The Justice also considered the list of competitors too broad. Moreover, the Court of Appeal held that the unreasonable parts could not be severed, as a result, the remaining parts was also unenforceable since cascading clauses were not used. In light of this decision, restraint clauses should be carefully drafted by using specific cascading clauses.
Moreover, the cascading clauses should be drafted in a clear and precise way, otherwise they would be deemed uncertain and unenforceable.
2. The restraint clauses must be reasonable.
As stated by the High Court of Australia in Buckley v Tutty (1971), if the restraint is contrary to public welfare, the restraint will be deemed unreasonable and unenforceable. In regard to cascading clauses, whether the restraint will be considered reasonable by the Court depends on the specific circumstances. Taking OAMPS Insurance Brokers Ltd v Hanna as an example, the key period of earnings is between the commencement and the expiration of the client’s insurance contract. Generally, an insurance policy works for a 12-month period. Clients are likely to be more attached to their insurance brokers because of the close association between them over the years, so it is likely that the clients will follow the departing insurance broker to the competitor of the company, which will inevitably affect the sales revenue of OAMP. Therefore, the Justice considered that 12-month period is the minimum necessary restriction to give OAMP an opportunity to cement its connection with the clients.
Generally, the reasonable standard of a restraint clause upheld by Australian courts is between 3 and 12 months with a specific geographical area and scope of restricted activities.
3. The restraint clauses are genuinely necessary to protect legitimate business interests.
The general principle regarding non-compete clause under Australian common law is whether the employer has a legitimate interest that the non-compete clause seeks to protect. Legitimate interests commonly include the employer’s confidential information or trade secrets, customers and clients of the business and employer’s staff. Basically, if the employee has routinely been exposed to confidential information in regard to customers, products, pricing and information, which could be used to the advantage of a competitor, the legitimate business interest exists.
Non-compete clauses are a common feature in most employment contracts of key employees. In order to balance the interests and rights of both employees and employers, cascading clauses are increasingly used in restraint clauses. In order to protect legitimate business interests, the employer should carefully draft the cascading clauses.