EMPLOYMENT NEWS, SEPTEMBER 2011

Will your restraint of trade hold up?

Restraints of trade are often derided as being "not worth the paper they are written on". A recent Employment Court decision (Hally Labels Ltd v Powell [2011] NZEmpC 63) shows that a well-drafted, carefully considered restraint of trade can, in fact, be enforced. The case concerned a restraint of trade which an employer sought to enforce against a high level employee who left to join a competitor.

Kevin Powell had been employed by Hally Labels since 1989. He had been subject to restraint of trade obligations since 2002 and in 2010 he rose to become the company’s Business Development Manager in New Zealand. Powell was offered a position with his employer’s competitor, Kiwi Labels. Following the offer he resigned from Hally Labels and openly informed them of the new role he intended to take up with Kiwi Labels.

The employer invoked the restraint of trade, which was for 12 months, five days after Powell’s resignation. The employee, through his lawyers, attempted to renegotiate the restraint by arguing that it was too onerous.

Under the restraint of trade clause in the employment agreement the employer could, within seven days of termination of the agreement, invoke a subclause preventing the employee from being employed in any business in the adhesive labelling industry in Australia or New Zealand which is either directly or indirectly in competition with the employer. In consideration, the employee would receive a payment equivalent to six months’ base salary.

Is the restraint reasonable and enforceable?

The burden of showing a restraint is reasonable and in the public interest lies on the employer attempting to enforce it; in this instance, the burden was on Hally Labels. The starting point is that an employer must show that it has a proprietary interest, such as a trade connection or trade secret, that it is reasonable to protect. In Hally there did not appear to be any serious challenge to the proprietary interest.

The reasonableness of the restraint is to be assessed at the time the covenant was entered into. The Court is to have regard to the:

• History of the employment;

• Nature of the interests being protected;

• Likely effect on the former employee of the covenant being enforced; and

• Relevant considerations of public interest.

In Hally, the Court summarised these matters for consideration into three essential elements:

• The activities the restraint seeks to restrict;

• The geographical area to which it applies; and

• The duration of the restraint.

The activities the restraint sought to restrict were limited to the adhesive label manufacturing industry. The Court found the activities were reasonably narrowed to include only the activities the employee had been directly engaged in during the course of his employment.

The restraint covered the fairly wide geographical area of both Australia and New Zealand. The Court found this was justified because of the competition between the two companies in both countries, enlarging on a previous Court of Appeal decision that the whole of New Zealand could be regarded as one market.

The employee’s main area for challenge was the duration of the restraint. He argued that 12 months was too long to be reasonable. In coming to its decision that the duration was indeed reasonable, the Court considered the employee’s senior position, his 22 years of experience with the employer and the fact that he had not objected to the inclusion of the restraint when bargaining for his employment agreement.

In addition, the employer had been prepared to pay a considerable amount in consideration for the restraint. The employee was also not prevented from gaining employment in any other industry.

In our view…

An employer seeking to implement a restraint of trade clause which will be enforceable needs to consider first, what the proprietary interest is that it is seeking to protect and then the ‘three essential elements’ identified by the Court: what activities the restraint seeks to restrict, the geographical area of the restraint and its duration. The facts of the particular situation need to be considered carefully alongside a general enquiry into the restraint’s reasonableness.

An employer also needs to bear in mind that if there is a dispute, it will need to convince the Court of the reasonableness of the restraint rather than the employee having to show it is unreasonable. It is clear that where there is a legitimate proprietary interest to protect, and where consideration has been identified, the Court is prepared to enforce a significant restraint of trade. However, it is important to ensure that restraints are tailored to the situation – a "one size fits all" approach will almost certainly fail. If you need any assistance with the enforcement of a restraint, or you want to consider negotiating a restraint with a senior employee, please contact us to discuss.