Legal update - Employment Court restrains restraints

7 October 2013

These days, it is commonplace for employment agreements to contain post-employment restraints of trade.  Usually, these restraints prohibit an employee from working for a competitor when his or her employment finishes.  On their face, restraints of trade are unlawful, but they can be upheld if they are reasonable.  In recent years, there has been a growing trend towards enforcing restraints of trade, provided that the restraint is no wider than necessary to protect the former employer's proprietary interest.

Following the full Employment Court's decision in Transpacific Industries Group (NZ) Ltd v Harris, though, it may be difficult for employers to enforce restraints of trade aimed solely at preventing competition.  This case is a reminder to employers to ensure that restraints of trade are no wider than necessary to protect their interests and to take care to ensure, if the restraint is a non-competition clause, the clause actually protects a legitimate proprietary interest (and does not merely prevent a competitor from making use of valuable employees).

Background

Transpacific had previously tried to enforce various restraints of trade against two former employees.  The restraints included prohibitions against working for a competitor, dealing with customers, soliciting employees and disclosing confidential information.  The case before the Employment Court was limited to whether the non-competition restraint was lawful, and in particular whether the restraint was solely designed to prohibit competition.

The restraints in both agreements were for a period of three months. Mr Green was prohibited from engaging in competitive economic activity in the North Island, whereas Mr Harris was only prohibited from competing in the Auckland region.  Mr Green held a reasonably senior position as Business Development Manager (Auckland), on a salary of $120,000.  Mr Harris was Business Development Manager (Small and Medium Enterprises), on a salary of $55,000.  After seven months at Transpacific, Mr Green resigned and accepted employment with a competitor.  Mr Harris resigned after nine months and also began working for a competitor.

The non-competition clause in the employment agreements stated:

"You acknowledge that the services that you are to perform for us may be of a special, unique, unusual, extraordinary and intellectual character. You appreciate that we may suffer serious injury if you took the knowledge and skills acquired during your employment with us and applied them for the benefit of a competitor of ours.  Accordingly, you agree that you shall not work for a Competitor either directly or indirectly for that period of time (plus any notice period not worked out), and in that area, as set out in Schedule C after the termination of this Employment Agreement."

The restraint was unreasonable

The Court held that the restraint, as written, was unreasonable and thus unlawful.  The employer had a proprietary interest in confidential information, though, that could justify altering the clause to make it reasonable.  However, the Court was concerned that redrafting would change the expressed reasons for the restraint, namely to prevent former employees taking up employment with a competitor based on his or her knowledge and skills acquired during employment with Transpacific.

The Court stated that the law will not allow a restraint to prevent employees from competing with a former employer or from using their skills, experience, general knowledge and know how.  If the Court modified the restraint, the clause would transform to one designed to protect confidential information that the employee acquired during employment.  This would be substantially different from the expressed reason for the restraint.  Also, because the three month restraint period had already expired, the Court considered it was inappropriate to modify the clause.  The restraint of trade was held to be unenforceable.

The law will not protect restraints of trade aimed at prohibiting competition

This decision raises important issues surrounding anti-competition restraints of trade generally.  In analysing the non-competition clause's purpose, the Court questioned whether the clause had been intended to protect the employer's confidential information (which could justify a restraint) or whether it was intended to make it difficult for competitors to solicit or gain the use of valuable employees.  If the latter was the true purpose, the restraint would be unenforceable regardless of reasonableness, because the law does not extend to prohibiting competition alone.

Transpacific argued that the restraint was designed to protect confidential information and could be modified to go no further than reasonably necessary to protect that information.  In this regard, the Court found that Mr Harris and Mr Green had access to confidential information, even though they did not use most of it.  Mr Green, however, had access to certain strategies sufficiently confidential to amount to proprietary interests that warranted a reasonable non-competition restraint.

However, as outlined above, the Court had reservations about whether the non-competition clause was actually intended to protect the confidential information.  The Court was guided by the fact that a third employee had left Transpacific to work for the same competitor.  Transpacific made no effort to enforce the non-competition restraint against that employee because in Transpacific's view, the employee "was more probably a liability than an asset".  The Court considered this indicated that Transpacific chose to enforce Mr Harris and Mr Green's restraints not to protect its confidential information, but because of the perceived value of the employee.  Although the Court did not go so far as to say this was Transpacific's motivation, the Court was concerned that the restraint acted predominantly to deprive competitors of valued employees.

Recent analysis of Transpacific and the significance of garden leave

Recently, in another Employment Court restraint case, Air New Zealand v Kerr, Judge Ford commented on the decision in Transpacific.  Although the Judge did not significantly develop the law in this area any further, he made broad comments on the enforceability of the Transpacific restraint.  In his view, the restraint in Transpacific could never have been enforced even if the employer had established a legitimate proprietary interest, because it sought to restrain employees from using knowledge and skills.  As a matter of law, knowledge and skills generally belong to an employee and cannot be subject to a restraint.  Judge Ford found that the restraint went further than permitted by law and the Court was required to turn to modification and ask whether the restraint could be modified to become reasonable.

In the case before him, Judge Ford found that Air New Zealand had a legitimate interest in its confidential information and that the six month post-employment non-competition restraint in Mr Kerr's employment agreement was reasonable.  However, the Judge decided not to enforce it because Mr Kerr had already spent the last six months of his employment on garden leave.  In Judge Ford's view, the six months' garden leave meant that Air New Zealand had already had all it needed to protect its confidential information.  Air New Zealand was not entitled to additional protection through the post-employment restraint, and Mr Kerr was free to start employment with its competitor, Jetstar.

The future of anti-competition restraints of trade

The Court's position towards restraints of trade has not changed significantly – restraints are still unlawful unless they are designed to protect an employer's legitimate interest.  But Courts may be more willing to look at the wording of a restraint and the justification behind it in analysing reasonableness.  As the full Court stated in Transpacific, an employer cannot enforce a restraint merely to protect itself against competition.  Nor can an employer try to restrain an employee from using his or her knowledge or skills.  We recommend that employers take extra care when drafting restraints of trade to ensure the clauses are specific and expressly address what proprietary interest the employer wants to protect.

Additionally, employers should be wary about using garden leave provisions alongside post-employment restraints of trade.  In Air New Zealand v Kerr, although the restraint was found to be reasonable and lawful, it was not enforced because the garden leave provision provided the employer all the benefits of a post-employment restraint.  Where an employee has already spent time on garden leave, an employer may find it is not entitled to the additional protection of a post-employment restraint.