Restraints of Trade and Protecting Confidential Information

Business, Journal,  Principals

In real estate, position is paramount, but information – clients and contacts – is just as important.

Agencies are entitled to protect their confidential information to which their employees are exposed during the course of their employment because, when the employment relationship ends, one does not want to equip one’s departing employee with the means to destroy the agency’s business. Which is not to say that an employer is entitled to be protected from legitimate competition. It is not. What an employer is entitled to do is to strike an agreement with its employee restraining competition for a prescribed period, and within a prescribed area.

However, the restraint of trade must be reasonable, having regard to the interests of the parties, and the interests of the public, and the information sought to be protected must be truly confidential and not in the public domain. Moreover, for any restraint to be upheld, the employer must not have breached the contract upon which it must rely to enforce the restraint.

These propositions are all illustrated by recent judgments of the Victorian Court of Appeal, the New South Wales Court of Appeal and the New South Wales Supreme Court.

Do not breach the contract

In Crowe Horwath (Aust) Pty Ltd v Loone,[1] a firm of public accountants and business advisors sought to enforce a restraint of trade clause against a departing employee. The Victorian Court of Appeal restated the well-known principles relevant when considering whether a restraint is reasonable and defensible, but the case did not turn on that issue.

While the restraint in Crowe Horwath may have been reasonable, the employer was not able to rely upon it because it had repudiated the employment agreement with the departing employee. It was held that the employer, by unilaterally changing the employee’s position description, and stripping him of the performance-based bonuses which had been negotiated as part of his contract, had indicated it no longer intended to be bound by the employment agreement of which the restraint was a part.

As a result of the employer’s repudiation of the employment agreement, the employee accepted the repudiation and terminated the contract. It was held, both at first instance and in the Court of Appeal, that where the employment relationship is brought to an end as a result of the employer’s wrongful conduct, then the employee will not be bound by any restrictive covenants in that employment contract.

The inconsistent restraints

The New South Wales Court of Appeal had cause to consider the reasonableness of a restraint upon departing real estate agents, and the agency’s attempts to protect its confidential information, in Agha v Devine Real Estate Concord Pty Ltd & Ors,[2] a decision delivered on 9th March, 2021.

That case concerned the breakdown of the relationship between a real estate agent, who was also a shareholder in the agency, another employee of the agency, and their former employer, Devine.

The relationship between Devine and the first agent, Mr Agha, was governed by both a shareholder’s agreement and an employment agreement, which contained clauses in restraint of trade and clauses protecting the confidentiality in Devine’s information. The second employee’s relationship with the agency was governed only by an alleged employment agreement.

It was held, on appeal, that the employment agreement relied upon by Devine against the second employee did not exist, which, of course, presented an insurmountable hurdle to the enforcement of any restraint against that departing employee.

As for Mr Agha, the employee who was also a shareholder, the conduct complained of by Devine involved Mr Agha and his colleague forwarding Devine’s client lists to their personal email addresses before their departure from the business, and scrambling the contact details of Devine’s clients in the database by randomly changing phone numbers and email addresses.

Mr Agha attempted to defeat the clause in the shareholder’s agreement which sought to protect the employer’s confidential information, that is, Devine’s client lists, by arguing that the shareholder’s agreement only prohibited the disclosure of the information to third parties and did not prohibit the employee from using the trade secrets or other confidential information of Devine for his own purposes.

Mr Agha also argued that the manner in which he had been permitted to use Devine’s confidential information during the course of his employment, including by sending it to his own private email address, showed that the information was not secret and, therefore, not confidential. That circular argument did not find favour with the New South Wales Court of Appeal.  It held that:

“Client contact lists were plainly confidential and not part of Mr Agha’s general know how. His arranging for the client list to be emailed to his personal email address when he was planning to leave Devine Group and set up in competition with it demonstrates that fact. Even in the absence of an express contractual restraint, the use or disclosure of the client information would be protected in equity, unless and until it came within the public domain. An employee is not entitled to remove lists which are the employer’s property, or to make copies or commit lists to memory.  Arranging for lists to be forwarded to his personal email address in order to have access to the client information is conduct of the same character”. [3]

Mr Agha had some success on appeal, however, in arguing that the judge, at first instance, had erred in conflating the restraint on competition which appeared in the shareholder’s agreement with the restraint on competition which appeared in the employment agreement. The difficulty arose because the restraint in the shareholder’s agreement was predicated upon a restraint on competition within certain postcodes for a period of three years, whereas the restraint in the employment agreement referred to the conduct of business within a certain distance from Devine’s office for a period of 12 months. The Court of Appeal held that the primary judge had erred in conflating the restraints set out in those two agreements because:

“That construction requires an amendment of the shareholder’s agreement by the insertion of the radius restraint in it and the amendment of the employment agreement by extending its period to three years”.[4]

However, that decision did not affect the final judgment, which was to the effect that the two agreements were intended to co-exist and, so, each agreement was given effect, on its own terms and for its stated purposes. It was also observed on appeal that, as the employment agreement was entered into after the shareholder’s agreement, then any inconsistency between the two agreements ought to be resolved on the basis that the later agreement would prevail.

Mr Agha also sought to erode the effect of the restraint on the grounds that the restraint imposed upon the employee in the shareholder’s agreement, which was framed by reference to the conduct of business within prescribed postcodes, sought to restrict the employee from engaging with a “regular customer” of the employer for a prescribed period.

The use of the term “regular customer” in the restraint was defined as meaning a person “having entered into not less than three transactions in the six months immediately prior to the date when this undertaking takes effect”.

Mr Agha argued there was no evidence at trial to support the proposition that there had been any proscribed dealings with a defined “regular customer”. That did not matter, because the definition of “regular customer” also made reference to a person who was “in the habit of dealing with the company”.

On that basis, despite the fact that there was no evidence at trial of dealings to satisfy the first limb of the definition of “regular customer”, it was held on appeal there was sufficient evidence to support the proposition that the persons whom Mr Agha had approached were otherwise “in the habit of” dealing with Devine.

As to the reasonableness of the restraint, which, in the employment agreement, was expressed to be for a period of not more than 12 months, within a radius of 6km from Devine’s office, it was held that it was irrelevant, in considering the reasonableness of the restraint, that Mr Agha had engaged in malicious breaches of his employment agreement; that is, by taking customer lists and scrambling Devine’s data, the only issue was whether the restraint:

“is assessed having regard to what was reasonable in the interests of the parties and the public when the agreements were made…

The restraints in the shareholder’s agreement and the employment agreement were reasonable in the interests of the parties and the public, having regard to the seniority of Mr Agha, and his position as a past shareholder was correct”.[5]

Agha is instructive for the proposition that, if the relationship is governed by two instruments, say, an employment agreement and a shareholder’s agreement, it is important that the restraints in those agreements are consistent. It is also instructive for the proposition that the court will look carefully at the terms used by the parties in drafting the restraints to determine whether the restraints are reasonable and in the interests of the parties and the public. It is not relevant to a consideration of the reasonableness of the restraint that an employee may have engaged in what otherwise might be considered to be “bad” behaviour.

The reasonableness of the restraint

In R T Forsyth Real Estate Pty Ltd v Psaltis,[6] a decision in the New South Wales Supreme Court handed down on 6th April, 2021, the Court was charged with considering the reasonableness of a restraint which sought to restrain the departing employee from engaging in real estate agent services “within a radius of 7.5km from the plaintiff’s office at [an address in Willoughby].

The issue for the Court was that the departing employee’s new office was outside the 7.5km radius, although a substantial part of the work undertaken by the departing employee at the new agency was conducted within the 7.5km radius. The employee argued that the restraint was triggered by the location of his new office, not where he did business. That argument failed.

The Supreme Court held that, in construing the restraint:

“the expression ‘in the businesses known as Stone Real Estate’…is reasonably capable of establishing that business was used in the sense of the commercial operations carried on by a particular real estate office”.[7]

That is, the restraint was operative within 7.5km of the office of the former employee, regardless of the fact that the employee’s new business office was outside the 7.5km radius – what mattered was where the business was done.

Conclusion

Restraints on departing employees are creatures of the contract. For an employer to be able to successfully rely upon the restraint, the employer cannot be in breach of the contract.  For the restraints to be enforceable, they must be reasonable, having regard to the interests of the employer, the employee and the public. Moreover, engagement in what otherwise might be considered to be “bad” behaviour by the departing employee is not the guiding consideration in assessing whether the restraint might be upheld or not.

The position remains – and the authorities in this regard go back to the 19th Century – that, whilst one cannot stop legitimate competition in the marketplace – because every person is entitled to earn a living – one is entitled, when entering into an employment relationship, to agree to a restraint with an employee which is reasonable and to take steps to protect information to which the employee would otherwise not be exposed, had the employee not entered into the employment relationship.

The words of the restraint will be carefully construed by the courts to determine what is reasonable and necessary.

Information is essential to any business. Business relationships are tenuous. Clients are fickle.  Negotiating all these factors, then, requires restraints with respect to engaging in a competing business, and in protecting confidential information, to be carefully drafted if they are to be upheld on any subsequent challenge in the courts.

REFERENCES:

[1] [2017] VSCA 181.

[2] [2021] NSWCA 29.

[3] See paragraph 132 of the judgment in Agha.

[4] See paragraph 145 of the judgment in Agha.

[5] See paragraphs 166 and 167 of the judgment in Agha.

[6] [2021] NSWSC 332.

[7] See paragraphs 37 of the judgment in Forsyth.

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