Time of reckoning for non-compete clauses

Background

Non-Compete clauses are under attack from various quarters.

Broadly speaking, non-compete clauses are a form of post-employment restraint that prohibit an employee from working for a competitor of their previous employer for a specified period in a defined geographic area.

The rationale for non-compete clauses being imposed on departing employees is to protect the legitimate business interests of the former employer, usually confidential information and customer relationships. This protection of the former employer, however, needs to be balanced against the right and need of the former employee to ply their trade or profession and earn a living. This balance is why there is a question as to the enforceability of non-compete restraints, with courts called upon to adjudicate as to whether a non-compete restraint should be enforced against a former employee and, if so, to what extent (in terms of time period and geographic scope). A court will not enforce the restraint beyond what is reasonably necessary to protect the legitimate business interests of the former employer seeking to rely upon it.

As a rule of thumb, it is senior employees who have significant access to confidential information and customer relationships. As such, there can be a proper basis for imposing a non-compete restraint against such employees as they can damage the business interests of the former employer by moving to a competitor. There is a real prospect a court will enforce a non-compete in such circumstances.

There is an increasingly influential view that employers are unfairly imposing restraints on relatively junior or lower-level employees who have not had access to confidential information or customer relationships, unjustifiably fettering those employees from availing themselves of opportunities with other employers and impeding labour market mobility overall. In these circumstances a court would likely give any attempt by an employer to enforce such a restraint against a former employee short shrift.

The Goddard Decision

In a recent Fair Work Commission unfair dismissal decision, Andrew Goddard v Richtek Melbourne Pty Ltd [2024] FWC 979 (16 April 2024) (Goddard), Deputy President Colman considered the impact of a non-compete clause imposed on the applicant on his obligation to mitigate the loss from his dismissal.

In Goddard the applicant was a salesperson selling grouting and grouting services. Deputy President Colman addressed the issue of the non-compete clause and its relevance to mitigation of loss at paragraph 27 of the decision.

Deputy President Colman, by way of background, observed:

"Section 392(2)(d) requires the Commission to consider the efforts of the person to mitigate the loss suffered as a result of the dismissal. Mr Goddard said that he had applied for hundreds of jobs on 'Seek', including sales jobs, in which he had a lot of experience. However, he said that he had not applied for jobs in the same sector as his previous work, because of the presence of a post-employment restraint provision in his contract of employment (clause 10.1). This stated that for a period of 12 months after the termination of his contract of employment, Mr Goddard was not to work as an employee or contractor or advisor or in any other capacity in any business which was 'engaged in activities substantially similar or identical to the Company and provides services substantially similar or services offered by the Company.'"

Deputy President Colman then provided commentary on the restraint, relevant to the applicant but also of interest more broadly on the issue of post-employment restraints imposed on 'ordinary' workers:

"One wonders why such restraint of trade provisions are so commonly found in the contracts of ordinary workers and whether they really protect any legitimate business interest of the employer, or merely serve to fetter the ability of workers to ply their trade, and to reduce competition for labour and services. Ordinarily, one would expect a person to have applied for jobs in the sector of their expertise as a reasonable step in mitigating loss. However the presence of a non-compete provision in his contract explains Mr Goddard's decision not to do so. Although the provision is most likely unenforceable on the basis that its scope is unreasonable, an ordinary worker cannot be expected to know this, and it is understandable that Mr Goddard would not want to risk embroiling himself in a legal controversy by acting contrary to an express provision in his contract. I therefore make no deduction in respect of Mr Goddard's decision not to apply for jobs that might have involved a prima facie contravention of the restraint of trade provision in his contract of employment."

The Goddard decision adverts to a disconnect between the legal principles relating to non-compete clauses (and other forms of post-employment restraint, such as non-solicit clauses) as applied by the courts and the way in which many employers seek to impose such restraints on employees, irrespective of whether those employees had sufficient access to confidential information and/or customer relationships to provide a sound basis for the restraints to be enforceable.

This situation often arises from employers using pro forma employment agreements which contain, as part of their standard terms, post-employment restraints such as non-compete and non-solicit clauses. Often little thought or consideration is given to whether to include the post-employment restraints or to their ultimate enforceability if tested. Indeed, there may be no intention on the part of the employer to ever enforce the restraints. Of course, employees are not to know this — as far as they are concerned there is a post-employment restraint in their contract and, as Deputy President Colman observed in Goddard, they may not want to be potentially drawn into a legal dispute with a former employer and so comply with the restraint, even if the employer had no intention of enforcing it.

Reviews in the USA and Australia

The decision in Goddard comes at a time when post-employment restraints are under review, both in Australia and the USA.

In the USA the Federal Trade Commission (FTC) has taken the drastic step of banning non-compete clauses in employment contracts completely. The release from the FTC highlights the extent of the ban:

"Under the FTC's new rule, existing noncompetes for the vast majority of workers will no longer be enforceable after the rule's effective date. Existing noncompetes for senior executives — who represent less than 0.75% of workers — can remain in force under the FTC's final rule, but employers are banned from entering into or attempting to enforce any new noncompetes, even if they involve senior executives. Employers will be required to provide notice to workers other than senior executives who are bound by an existing noncompete that they will not be enforcing any noncompetes against them."

As such, only existing non-compete clauses for senior executives (a cohort of less than 0.75% of workers) will continue to be enforceable. There can be no new non-compete restraints for any employees, including senior executives.

In Australia, the Competition Review Taskforce is presently examining non-compete clauses and various other form of employment restraints, with submissions being sought.

The Issues Paper released by the Competition Review Taskforce provides this summary:

"Several issues have been identified relating to the use and impact of non-compete clauses. Many issues identified in empirical analysis have been affirmed as practical issues affecting Australia today through the Competition Review Taskforce's early engagement, and include concerns about:

• the "chilling effect" of restraint clauses on worker mobility, particularly among lower-income workers, to choose better-paying jobs, and the ability for businesses to start up, recruit talent and grow;
• the high cost of litigation, the lack of clear guidance and 'bright line' rules, and the use of cascading clauses or the 'blue pencil test', which can leave both workers and businesses with an unclear understanding whether an agreed restraint will be upheld as reasonable and enforceable; and
• the economic consequences of potentially inefficient allocation of labour and information, which may be hampering productivity growth and innovation."

These are reasonable concerns but can be addressed without banning non-compete clauses altogether. In determining the enforceability of such restraints the courts, through principles developed over decades of judicial consideration, carefully endeavour to ensure an appropriate balance is struck between the right of employers to protect their legitimate business interests and the right of employees to change positions and earn a living. The Issues Paper and related materials put much reliance on anecdotes of employers trying it on by sending threatening letters to vulnerable employees, relying on restraints that are patently unreasonable in the circumstances. It is instructive that there are no court decisions cited showing how a restraint has actually been enforced against such employees. Unfortunately, the bluff tactics of a few rogue employers seem to be given greater weight than the significant and nuanced body of law that is applied by the courts.

Observations

A few observations on the issue:

1. The inappropriate imposition of post-employment restraints on lower-level employees could be partially countered by education or information on the way such restraints operate, reassuring such employees that they are highly unlikely to be enforceable against them. The reality is that non-compete clauses can only be effectively enforced against a relatively small cohort of employees. It is important to narrow the gap between perception and reality to minimise abuse of restraints by employers and embolden employees to call out blatant bluff tactics.
2. One possible option for dealing with this problem is to prohibit non-compete clauses for those earning less than the high income threshold under the Fair Work Act ($167,500 per annum exclusive of compulsory superannuation) although this is still a blunt approach that does not take account of the nature of the position subject to the restraint. Remuneration alone is not always determinative of access to confidential information and customer relationships.
3. While the Issues Paper refers to the "chilling effect" of restraint clauses, many employees hold the view that such restraints "aren't worth the paper they're written on", ignore the restraints and start with the new employer. While this can be a somewhat simplistic approach on the part of such employees, any assumption that all employees subject to non-compete clauses act is if they are constrained by them is flawed.
4. Is it seriously suggested, to take an obvious example, that the CEO of a major company could finish employment and start as the CEO of its direct competitor the next day? This is the corollary of a complete ban on non-compete clauses. It is unduly dismissive of the need for employers to protect legitimate business interests, making no substantive difference to ordinary employees while liberating senior executives.
5. If non-compete clauses are banned then it is likely employers will look to longer notice periods and lock employees into extended periods of garden leave to give the employer an opportunity to protect confidential information and customer relationships. Extended notice periods can have a similar negative impact on job mobility yet are not, as a general proposition, subject to the same issues of enforceability as non-compete clauses. If non-compete clauses are banned then extended notice periods (with a right to put the employee on garden leave) will likely become an even more important business protection mechanism than it is presently.
6. The Issues Paper is rightly critical of the uncertainty for employees created by cascading restraint clauses, which can create a bewildering array of potential combinations. From a legal perspective, it is a clever drafting device for employers to hedge bets and overcome the "all or nothing" test applying to enforceability at common law. From a commercial perspective it is a bizarre, confusing contrivance, especially for employees unfamiliar with it. It is a contractual form of the "Choose Your Own Adventure" books from childhood. If there is any reform needed, consideration should be given to the adoption of legislation similar to the Restraints of Trade Act (NSW) in all jurisdictions, to hopefully obviate or at least minimise the need for cascading clauses.

Proposals to ban non-compete clauses are largely predicated upon speculative economic theory and are being sold by a few anecdotes about employers making baseless threats to employees who it seems, unfortunately, did not seek any advice or guidance as to what their rights actually were (which could have been quickly and easily rendered by an appropriately qualified person). It is a classic case of throwing the baby out with the bathwater.

For further information please contact:

Michael Byrnes, Partner

Phone: +61 2 9233 5544
Email: mjb@swaab.com.au

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.