Following on from our previous article on Enforceable Restrictive Covenants vs Unenforceable Restraint of Trade Clauses in Commercial Contracts, this week we will focus on the treatment of restrictive covenants under Australian employment law.

In Australian law, the distinction between an enforceable restrictive covenant and an unenforceable restraint of trade hinges on a presumption of invalidity. In other words: the law starts from the position that these clauses are void as a matter of public policy because they restrict a person’s right to work and suppress competition.

For a restrictive covenant clause in an employment contract (such as a non-compete, or an anti-poaching clause) to be enforceable, the employer bears the heavy legal burden of proving the restraint clause both seeks to protect a legitimate protectable interest of the employer, and is reasonable to do so.

The reasonableness test

The seminal leading case on the matter is Herbert Morris Ltd v Saxelby [1916], an English law case where the employer had imposed upon its employee a 7-year restriction from working directly or indirectly in a similar business. The court held this to be unreasonable and contrary to public policy in that, instead of protecting the employer’s business, it prevented the employee from using his skills and experience, stating that the clause:

“[…] put him in such bondage as regard to his own labour that he must, for seven years of his life, become an exile.”

In Australia, the common law principle set out in Herbert Morris and later case law, translates into the following two-pronged test, which a restrictive covenant in an employment contract must meet to be enforceable:

• It must seek to protect a legitimate protectable interest of the employer; and
• It must be no more than reasonable for the protection of that interest.

Part 1: Legitimate protectable interest

The restraint must protect something more than just freedom from competition. It must protect. For instance:

• Confidential information or trade secrets: e.g., specific “know-how” or pricing playbooks.
• Customer connections: where the employee is the “human face” of the business (e.g., a general manager).
• Staff stability: protecting the workforce from being poached en masse.

Part 2: Reasonable to protect the employer’s interest

The restraint must go no further than is absolutely necessary to protect the employer’s legitimate business interest interest. Courts look at:

• Duration: between 3 and 12 months is common, whereas long restrictions (e.g., beyond two years are rarely enforced in employment, though common in business sales).
• Geographic scope: The geographic scope of the restriction must match the actual area where the employee worked (e.g., “5 km from the Sydney CBD” vs. “Australia“).
• Activity: the restriction cannot ban the person from the entire industry if non-solicitation of specific clients would suffice.

Cascading clauses

To increase the chances of a restrictive covenant being enforceable, it is common practice (and recommended) to draft cascading provisions as to its duration (e.g., “24 months or, if held to be invalid; 12 months or, if held to be invalid; six months”) and geographical scope (e.g., “Australia or, if held to be invalid; New South Wales or, if held to be invalid; Sydney”).

This mitigates against the uncertainty of what a court might actually consider a reasonable restraint clause, by allowing the court to amend the restraint period and scope to a reasonable level that has been pre-agreed in the employment contract.

At the same time, care must be taken however not to draft the cascading provisions in such a way that might make the clause void due to uncertainty, as was the case in Austra Tanks Pty Ltd v Running (1983).

No court power to “read down” unenforceable clauses

Except for New South Wales, the courts have no power to “read down” a clause that was unenforceable in its originally drafted form in such a way as to delete its offending provisions and reformulate it to make the rest of it enforceable.

Cascading clauses are the exception, as they entail the court “crossing out with a blue pencil” parts of a provision drafted in such a way that that the rest of it is enforceable without redrafting the structure of the provision (Hanna v OAMPS Insurance Brokers Ltd Ltd [2010]).

The NSW exception: Restraints of Trade Act 1976

In New South Wales, courts have a statutory power to “read down” an unreasonable restraint. Under Section 4(1), a restraint is valid to the extent it is not against public policy, and the court can effectively turn a two-year, Australia-wide ban into a six-month, Sydney-wide ban that it deems reasonable, rather than deleting it entirely.

Enforceability when the employer has breached the contract

This point is critical: even if a restraint clause is potentially valid, if an employer breaches the employment contract (e.g., by not paying a bonus or wrongfully dismissing the employee), the employer may lose the right to enforce the restraint entirely.

Ban on restraints from 2027

It is important to note that the Australian Government has moved to ban non-compete clauses in employment contracts for workers earning below the high-income threshold (currently set at $183,100 per annum).

The ban will commence in 2027 and will not affect workers earning above the high-income threshold, for whom the above tests will remain valid.

The Treasury is also considering legislating changes in connection with non-solicitation clauses for clients and co-workers, no-poaching agreements, wage-fixing agreements and non-compete clauses for high-income workers.

Consider auditing your existing employment contracts, especially those below the high-income threshold, for non-compete clauses, and replace them with suitable alternative protections compliant from 2027 onwards.

Get in touch with Praetorium Law to discuss how to best approach the subject of restraint clauses in your employment contracts, including ensuring compliance with the ban on non-compete clauses below the high-income threshold whilst providing adequate protection to your business.

Email: info@praetoriumlaw.com

Tel: 0410 752 667