When might you be prevented from participating in a competing business?
Clients often ask us questions in relation to whether they are allowed to establish, operate and/or otherwise participate in a business that is similar to or competes with a business they have previously been involved with as an employee, a senior executive, corporate officer (e.g. director or secretary), shareholder, partner or some other association.
The answer to this question so often turns on the specific facts and circumstances, but in this update, we seek to highlight some of the key circumstances which, if they apply to you, might restrict you from participating in a competing business. These include:
obligations arising from a contract you have entered into (for example, an employment agreement, a franchise agreement, shareholders’ agreement, sale of business agreement etc.);
obligations as an ‘officer’ of a company incorporated under the Corporations Act 2001 (Cth) (e.g. as a director, secretary or senior executive); and
obligations as a fiduciary to interested third parties and stakeholders.
We examine each of the above scenarios further below.
(1) Contractual restraints – restraint of trade provisions
Restraint of trade clauses are contractual provisions which seek to prevent a person from engaging in certain activities in order to protect the business interests of another party. These restraint of trade clauses are seen in a number of commercial agreements, but most commonly in employment agreements, shareholders’ agreements and business sale agreements.
Although the starting presumption is that restraint of trade clauses are unenforceable as they are contrary to public policy, a Court may uphold a restraint as enforceable if the following can be established:
there are legitimate business interests of a party to protect; and
the restraint imposed is no more than is reasonably necessary to protect that legitimate business interest.
The onus is on the party seeking to rely on the restraint of trade clause to prove that the above requirements are satisfied in the circumstances.
Employment agreements
The most common example of the use of restraint of trade provisions are in employment agreements. Some employment agreements (particularly for senior executive and managerial roles) contain a non-compete clause which seeks to prevent the employee from competing with the employer (e.g. working for a competitor or establishing and operating a competing business) for a period of time and throughout a particular geographical region following employment with that employer.
Non-compete clauses are often drafted as a ‘cascading’ clause containing a range of time periods and geographic regions in descending order in respect of which the non-compete restraint will apply. If the greater period or region is unenforceable (i.e. the restraint is not considered reasonably necessary to protect the legitimate business interests of the employer in the circumstances), then the next lesser time period or region will apply and so on until a combination of time and region that is reasonably necessary to protect the legitimate interests of the employer is arrived at.
It is important to note that non-compete clauses are often also accompanied by:
a non-solicitation clause which seeks to prevent an employee from soliciting customers, clients and employees during the course of their employment and for a set period of time after the end of their employment (which is also another type of restraint); and
provisions which prevent the use and misuse of confidential information (e.g. trade secrets, business contacts / client lists and other commercially valuable information to the former employer’s business etc.).
Are there legitimate business interests of the employer to be protected?
As mentioned above, the Court must be satisfied that there are legitimate business interests of the employer to be protected in order for the restraint to be enforceable. The restraint must extend beyond merely seeking to prevent the former employee from competing with their former employer (i.e. it cannot be anti-competitive in nature). There must be a real risk that the employee is likely to be able to take an unfair advantage of the knowledge, information and influence (being protectable proprietary interests of the former employer) gained during the course of their employment to the detriment of their former employer.
Examples of legitimate business interests of an employer which are protectable include goodwill, trade secrets, customer connections and confidential information etc.
Generally, the Court is more likely to determine that there are legitimate business interests to be protected where the employee:
was employed in a senior position (e.g. director, executive officer, senior managerial position etc.);
had regular dealings and contact with clients as a representative of the business (i.e. had valuable client relationships / customer connections); and
had access to confidential information which would be considered commercially sensitive and valuable information to the business.
What is considered ‘reasonably necessary’?
Whether the restraint is considered ‘reasonably necessary’ to protect the legitimate business interests identified in the circumstances will also depend on the duration of the restraint, the geographic area to which the restraint will apply and the specific activities that the restraint seeks to prevent.
For example, in the case of Allied Mills Pty Ltd v Miners [2013] NSWSC 1117, the NSW Supreme Court determined that a restraint which sought to prevent the employee from working for a competitor located in New Zealand was considered not to be reasonably necessary to protect the employer’s legitimate business interests as the likelihood of genuine harm was remote.
In contrast, the Court upheld a restraint in the case of Janala Pty Ltd v Hardaker (No 3) [2023] NSWSC 446 which prevented an employee from competing with his former employer for the period of 6 months as he had developed strong personal relationships / customer connections throughout his 7 years of employment (being the principal point of contact for customers) and had access to commercially sensitive information such as client lists, supplier lists, pricing information and daily revenue reports in his role as a project manager.
Other commercial agreements
The restraint of trade provisions described above (i.e. non-compete, non-solicitation and confidentiality provisions) are also commonly included in the following contexts and commercial agreements:
shareholders’ agreements – to prevent an exiting shareholder of a company from competing with the company in order to protect the business interests of the company;
business sale agreements – to prevent the vendor from competing with the business after the business has been sold to the purchaser in order to protect the goodwill of the business and the interests of the purchaser; and
franchise agreements – to prevent a franchisee from competing with franchised businesses within the franchise system following the end of the term in order to protect the business interests of the franchisor.
As a general observation, Courts have generally been more willing to enforce restraint of trade provisions contained in agreements between commercial parties (as compared to those in employment agreements) given that the factual circumstances in those contexts more readily support a conclusion that the restraint is reasonably necessary to protect a party’s legitimate business interests.
(2) Statutory and fiduciary obligations as an officer of a company
In some circumstances, a former director or executive of a company (i.e. someone with a senior management role in the company) may be restrained from working for a competitor or operating a competing business by reason of certain statutory duties owed under the Corporations Act 2001 (Cth) (Act) and as a fiduciary of the company despite the absence of an agreement containing a contractual restraint.
Directors and some executives of a company owe certain duties to the company as a whole, including the following:
duty to act in good faith, for a proper purpose and for the best interest of the company pursuant to section 181 of the Act;
duty not to improperly use his/her position to gain an advantage or to cause detriment to the company pursuant to section 182 of the Act;
duty not to improperly use information of the company to gain an advantage or to cause detriment to the company pursuant to section 183 of the Act; and
fiduciary duties to act honestly, exercise due care, to avoid conflicts of interest and not to profit in addition to the duties described above.
Any decision to compete with or participate in a competing business will therefore need to be made in the context of the duties referred to above.
In the case of Advanced Fuels Technology Pty Ltd v Blythe & Ors [2018] VSC 286, the Supreme Court of Victoria confirmed that the fiduciary duties of a director do not cease upon resignation. However, the scope and duration of a former director’s fiduciary duties after resignation will depend on the specific circumstances and facts of each individual case. Some relevant factors taken into consideration by the Court in this particular case include:
the conduct of the fiduciary leading up to their resignation as a director or officer of the company and the circumstances of the resignation (e.g. if steps which are considered to be against the company’s interests were taken in anticipation of the resignation and subsequent involvement in a competing business);
whether there was any improper use of confidential information;
whether any opportunities pursued or taken by the fiduciary or their competing business were maturing business opportunities that the company was actively pursuing; and
the similarity between the maturing business opportunities of the company and those opportunities taken by the fiduciary or their competing business.
(3) Fiduciary duties to third parties and other stakeholders
Depending on the specific circumstances, a fiduciary relationship may also exist in the following scenarios:
between one partner to each other partner under a partnership;
between one shareholder to each other shareholder of a company; and
between joint venturers under a joint venture.
The existence of such fiduciary relationship will enliven the fiduciary duties referred to above.
In light of the above, it is prudent that one is mindful of any contractual restraints, statutory duties and/or fiduciary duties of which they may be bound by prior to establishing, operating or otherwise participating in a competing business.
Disclaimer: The content of this publication is provided for general information purposes only. It does not, nor is it intended to, constitute legal advice and must not be relied upon as such. Should you wish to obtain advice pertaining to a matter covered by this publication, we recommend you get in touch with us to discuss your specific circumstances.
This publication was written by Nicole Tram, Lawyer and Winston Lay, Director.