We are often asked to advise in relation to the application, interpretation and inclusion of restraint of trade provisions in two areas:
a) The sale and purchase of a business or enterprise.
b) In employment or service contracts.
Over the years the Courts have interpreted restraint clauses applying basic rules and principles but have always distinguished between restrictive covenants encompassed in a sale or purchase of a business as opposed to what is normally described as employee cases where different tests are applied.
In reviewing the recent high profile Supreme Court Decision between Vision Eye Institute and Dr David Kitchen, Supreme Court Justice Applegarth has given a very succinct summary of the relevant provisions and their applications.
Dealing with provisions contained in a Sale Contract to protect the Goodwill being sold and purchased Judge Applegarth states:
“The general principle is that a restraint of trade is prima facie invalid, but may be enforced if it affords no more than reasonable protection to the party in whose favour it is imposed and is not injurious to the public.
The party who seeks to enforce the restraint has the onus of proving that the restraint is reasonable as between the parties. The restraint must operate to protect a legitimate interest of the covenantee. The test is whether the restricted covenant exceeds what is reasonable and necessary for the protection of the legitimate interest.
The reasonableness of the restraint is determined at the date of entry into the agreement. The issue is whether the agreement was a reasonable one to make at the relevant time, having in mind the best estimate the parties could make for the future…
…The buyer of a business has a legitimate interest in protecting its investment against competition by the seller, since without a covenant against competition the buyer would not get what it was contracting to buy. A covenant against competition is reasonable if it protects the Goodwill that is purchased. The question of whether the protection given to the covenantee is excessive can give rise to issues about the width of the activities that are restrained, the area or scope of the restraint and whether the duration of the restraint is unduly long…”
The closing sentence in the above quote gives reason for the heading above ‘When size does really matter’. Basically what Judge Applegarth is saying is that restraint of trading clauses are generally considered invalid by the Courts until proven valid, and the larger the geographical area and the longer the period of restraint the less likely a Court is to enforce them. As is common in many sale contracts, there are cascading provisions in relation to both the geographical and time of the restraint, and the reason these clauses are drafted that way is because of the way they have been interpreted by the Courts in the past. As I have said in the introduction to this article, Courts have applied different standards or interpretations between sale restraints to protect Goodwill as opposed to restraints against
employees. This case, however, involved both because not only did Dr Kitchen and/or his company sell his practice to the Vision group, Dr
Kitchen was then re-employed and in fact there were two different restraint provisions that were being tested by the Court. One in the “Sale Agreement” and one in the Service/Employment Agreement.
Judge Applegarth said this about the different test in employee cases:
“The principal interest which can be protected by a restraint against a former employee is the benefit of the former employer of the relationships with its customers. In general, restrictive covenants restraining an employee will be scrutinised more strictly than a covenant in relation to the sale of a business…
…In some cases, an employment contract is entered into by the seller or an individual associated with the seller of a business,such as the seller’s major Shareholder or controlling mind. Such a case tends to be treated differently to an ordinary employee case. In some cases, the relevant restrictive covenant is found only in the Share Purchase Agreement. In the present case, similar restraints are found in both the Service Agreement and in the Share Purchase Agreement.”
Later on in the Judgment, Judge Applegarth discussed in detail the restraints in the Service Agreement “Employment Contract”as opposed to restrictive covenantsin the Share Purchase Agreement.
Both Agreements were for similar periods, however the restraint in the Share Purchase Agreement had a different geographical area namely the whole of Queensland, whereas the restraint in the Service Agreement only related to the areas that Dr Kitchen had practised.
Judge Applegarth found restraint in the Share Purchase Agreement:
“… was excessive in terms of its geographical reach because it extended beyond the area of Central Queensland in which the practices that were acquired operated and were expected to expand. Vision was not entitled to enforce such a geographically wide restraint in order to protect its legitimate interest as the buyer of those practices.”
Another interesting aspect of Judge Applegarth’s enquiry into the relevant principles to be applied in these cases relates to the non-solicitation of clients and/or staff. In his view the Judge found that the provisions in both the Share Purchase Agreement and the Service Agreement which prohibited the non-solicitation of both clients and staff were reasonable and were enforceable and further found that Dr Kitchen had breached both of these provisions.
Another important aspect of Judge Applegarth’s Judgment is that he describes that each restraint provision, whether it be in a Sale Agreement or an Employment Agreement must be looked at in detail and judged on its own merits. The Judgment in this matter is very interesting, provides a good summary of the law in respect to restrictive covenants and no doubt will be closely watched because of the dollar value of the amounts of compensation being claimed. For example, Dr Kitchen sold his business for some $22 Million which was made up of both cash and shares in Vision Eye and also a commencement base wage was $400,000.00 per annum plus bonuses. These bonuses related to
both the profitability of the businesses going forward and Dr Kitchen’s ability to recruit further Ophthalmologists into the Vision group.
The bonus for each one so recruited was $115,000.00 per Ophthalmologist. Dr Kitchen whilst remaining in employment of Vision Eye in fact was successful in recruiting several further Ophthalmologists. Clearly Judge Applegarth thought that Dr Kitchen’s base remuneration was reasonable bearing in mind the following comment:
“Someone being paid a base salary of $400,000.00 and an annual performance bonus hardly qualifies as a wage slave.”
Damages are yet to be assessed and it will be interesting to see whether both the findings of the Court in relation to the breaches by Dr Kitchen of his restrictive covenants and/or the ultimate award of damages will be subject to appeal.
