This article was first published in the second-quarter 2016 edition of Personal Finance magazine.
Employees often sign a restraint-of-trade agreement when they enter into employment contracts without giving proper thought to the consequences and the effect it might have on their career advancement and future employment. The rationale is usually “I signed because I needed the job”. As understandable as that may seem, the adverse effects of signing an agreement without proper guidance may turn out to be an expensive nightmare, Phil Davel, a legal adviser at trade union Solidarity, says.
A restraint of trade is a contract in which an employee agrees with his or her employer to restrict his or her freedom in the future to trade with an external party in the same industry.
“In most cases, the employee is in the weaker bargaining position and is not really able to negotiate the terms of the contract. The terms of the restraint clause may even be harsh and unfair and may restrict the employee from following her occupation even when she would not be competing with her former employer. The courts are aware of this problem and have formulated rules relating to the validity and reasonableness of restraint of trade,” Davel says.
Ross Alcock, a director in the employment law department at ENSafrica, says the purpose of a restraint of trade is not to stop a former employee from competing fairly and lawfully with his or her former employer. Instead, it gives employers a means of protecting their proprietary interests and confidential information – in other words, their trade secrets and relationships with existing or prospective customers – by preventing employees from engaging in the same type of business as the employer for a specified period of time and in a specified area after their employment has been terminated. This protects the employer from the risk of the former employee disclosing information to a competitor that would give the competing business an unfair advantage.
Proprietary interests that an employer can seek to protect include confidential information (trade secrets) and trade connections (relationships with the employer’s customers and/or suppliers, or potential customers and/or suppliers).
Alcock says the courts have held that an employer’s proprietary interest does not include the expert knowledge that an employee has acquired, either through training, or through his or her employment. Therefore, an employee cannot be restrained from using such expert knowledge after the termination of employment.
Davel says that, when a court is faced with deciding whether or not a restraint of trade is enforceable, it has to balance the common-law principle that “agreements must be kept” with the provision in section 22 of the constitution that every citizen has the right to choose his or her trade, occupation or profession freely.
Commenting on these competing considerations, the Supreme Court of Appeal, in Reddy v Siemens Telecommunications (Pty) Ltd (2007), held that it was in the public interest that parties should comply with their contractual obligations and that all persons should be productive and be permitted to engage in trade and commerce. “Both considerations reflect not only common-law, but also constitutional, values. Contractual autonomy is part of ... the constitutional value of dignity, and it is by entering into contracts that an individual takes part in economic life. In this sense, freedom to contract is an integral part of the fundamental right referred to in section 22.”
The judgments of the former Appellate Division and the Supreme Court provide the courts with precedents to follow. One case that is often cited in this regard is Basson v Chilwan and Others (1993), in which Judge Petrus Nienaber identified four questions that should be asked when considering the reasonableness of a restraint:
1. Does one party have an interest that deserves to be protected after the employment contract has ended? If so, is that interest threatened by the other party?
2. In that case, does such an interest weigh against the interests of the other party?
3. Is there an aspect of public policy (principles embodied in the constitution, the law and judicial decisions) apart from the relationship between the parties that requires that the restraint be maintained or rejected?
4. In light of section 36(1) of the constitution, does the restraint go further than necessary to protect the interest?
Alcock says it can be said that, if the answer to the first three questions is “yes” and the answer to the fourth question is “no”, it is more than likely that the restraint will be found to be in accordance with the principles of public policy and therefore reasonable and enforceable. However, he says it is important to note that the enforceability or otherwise of a restraint of trade will depend entirely upon the factual circumstances of each individual case. So it is difficult to lay down any general rules in this regard.
The following are some of the more specific factors that the courts will consider when determining whether or not to enforce a restraint-of-trade agreement.
Davel says an employer that relies on a restraint to protect trade secrets must show that the information or methods are unique to its business and that such information is not already in the public domain. The Durban High Court held (Hirt & Carter (Pty) Ltd v Mansfield & Another (2008)) that the information that an employer wanted to protect “must be objectively useful to a competitor” in order to be confidential between it and its former employee.
However, the Supreme Court in Reddy v Siemens Telecommunications (Pty) Ltd (2007) ruled that it was not necessary to find that the former employee actually did or would use trade secrets and confidential information in his new employment; it was sufficient that he could do so.
The Labour Court (David Crouch Marketing CC v Mark (2009)) found that, for a restraint that sought to protect trade connections to be enforced, there had to be such a strong customer relationship and “attachment” that customers would “easily be induced” to follow the employee to the former employer’s rival. Before arriving at that conclusion, the court will consider several factors, including the frequency and duration of interactions with the clients, the employee’s personality, where the contact takes place, and the knowledge that the employee gained with regard to the clients’ needs and requirements.
The court will judge the reasonableness of a restraint’s duration and geographical area in the context of the interest that it seeks to protect. If the scope of a restraint-of-trade clause is broader than necessary, it will not be enforced.
Vagueness and “one size fits all”
Alcock says a restraint should not be too wide and general. The purpose of a restraint is not to stifle competition, but to protect the employer’s specific proprietary interests. It is possible, therefore, that a blanket restraint would be found to be unreasonable in the case of one employee, but reasonable in the case of another. Accordingly, employers should be careful about using a “one size fits all” approach for all levels and types of employees without considering what proprietary interests it seeks to protect.
The term “golden handcuffs” refers to a financial incentive designed to keep an employee from leaving a company. A payment that accompanies a restraint contract is regarded as compensation for the employee withdrawing from the industry, Davel says. Alcock says the enforceability of a restraint does not depend on whether or not an employee has been compensated for the restraint; however, the fact that an employee was paid for a restraint would be one of the factors considered by the court when it determines the reasonableness of the restraint.
Reason for termination of employment
Alcock says that, generally speaking, a restraint-of- trade agreement can be enforced even in circumstances where the termination of the employee’s employment is unfair, wrongful or unlawful, provided the agreement specifically states that the restraint applies irrespective of the reason for the termination of employment.
However, a court would not enforce a restraint where it is found that the employee’s employment and restraint were based on fraud. For example, an employee is hired and fired with the sole object of imposing a restraint upon him or her.
Elimination of competition
The Supreme Court of Appeal (Automotive Tooling Systems (Pty) Ltd v Wilkens and Others (2007)) upheld the principle that a restraint was not enforceable if its sole purpose was to exclude or eliminate competition. For a restraint to be valid and enforceable, it must protect a legally recognised interest of the employer.
Alcock says an employer may not force an employee who was not subject to a restraint of trade when he or she commenced employment to sign a restraint thereafter. However, where employees are promoted or appointed to new positions where, for example, they may become exposed to the employer’s confidential information, an employer could include a restraint provision as a “trade off” for the new position.
Davel says the principles of the law of contract dictate that an employee who alleges that he or she was forced to sign a restraint of trade after signing a contract of employment that did not contain a restraint-of-trade clause must prove that he or she signed the restraint for fear of jeopardising his or her employment.
Alcock says that, where a portion of a restraint has gone further than is reasonable to protect an employer’s interests, the courts may agree to enforce a restraint provision in part by removing those parts of the provision that are unreasonable and therefore unenforceable. Although the courts are willing to amend the terms of a restraint of trade in line with the requirements of public policy, they will not amend the terms of a restraint provision to such an extent that it amounts to the complete redrafting of the restraint. If a party wants the court to amend the terms of a restraint and/or to remove parts of it in order to ensure the reasonableness, and therefore the enforceability, of the restraint, a specific case must be made for this.
If you are a bound to a restraint-of-trade agreement by your current employer, you need to be fully aware of the terms of the restraint and understand exactly what it prevents you from doing. If you are contemplating undertaking an activity that may be in breach of the restraint clause, you should consider the consequences carefully, Davel says.
As with any other agreement, when a party to a restraint attacks its validity, the onus is on him or her to establish that the agreement is unreasonable. To this end, Alcock says, a former employee seeking to invalidate a restraint will have to demonstrate that the restraint was in conflict with section 22 of the constitution, because it unreasonably restricts his or her right to trade or to work.
Davel advises employers and employees to obtain a professional opinion, preferably from an attorney who specialises in the law of contract, before drafting or signing a restraint of trade.
A RESTRAINT CAN LEAVE YOU STYMIED
A case heard in the Northern Cape High Court illustrates how a restraint-of-trade clause could prevent you from exploiting a business opportunity years after you leave your employer.
Pierre Jean and Margaret Duraan managed the Kimberley branch of Freepak, which sells packaging material to wholesale and retail customers in the Northern Cape, Free State and Gauteng. The Duraans were “the face of the business” for 16 and 15 years respectively.
In 2004, their employment contracts were put in writing. One clause included a restraint of trade, which stated that, if their employment was terminated, for whatever reason, they may not, for five years following termination, be involved in any other business that sells products similar to Freepak’s.
In February 2013, Mr Duraan was dismissed after a disciplinary hearing, and Mrs Duraan subsequently resigned. The Duraans decided to open a business that sold packaging material. As a result, Freepak applied to the High Court to enforce the restraint-of-trade clause.
Freepak argued that the Duraans had been privy to confidential information and, as a result, were aware of the pricing structure of its products, profit margins and the discounts that could be negotiated with clients. Freepak also sought to protect its customer connections on the basis that the Duraans had virtually exclusive and personal contact with its clients in the Northern Cape, were in possession of its clients’ cellphone numbers, and their relationship with clients was such that clients would regularly call one of the Duraans directly to place orders, discuss their business needs and negotiate pricing.
The Duraans argued that the restraint was invalid and unenforceable, because it was too broad and would prevent them from participating in the only economic activity in which they had any experience. They also said it would be unreasonable to enforce the restraint in circumstances where Freepak had dismissed Mr Duraan, which led to the resignation of Mrs Duraan.
The Duraans also challenged the restraint on the basis that Freepak did not have a proprietary interest worthy of protection, because they were not privy to any confidential information, since all decisions were taken at Freekpak’s head office in Bloemfontein.
They did not dispute that they had client contact details, but argued that this was not indicative of a customer connection, and that a distinction should be drawn between possession of the list of clients and customer connections.
The Duraans argued that they largely acquired knowledge of the business as a result of their own drive, personality and initiative, which, they contended, constituted skills, general knowledge and experience that they could not be restrained from utilising.
The court found that Freepak did not make a compelling case that the Duraans had been privy to its confidential information.
However, turning to the possibility of a protectable proprietary interest in the form of customer connections, the court relied on the principle contained in the judgment of Den Braven SA (Pty) Ltd v Pillay and Another (2008). This principle provides that, once it has been concluded that an employer has trade connections through customer contact that could be exploited by a former employee working for a competitor trading in similar products, there is a risk of harm to the employer.
The court found that the Duraans did have a customer connection with Freepak’s clients. The court accordingly found that the risk of harm to Freepak’s customer connections could not be discounted in circumstances where the Duraans had been the “face” of Freepak’s Kimberley branch for more than a decade and had almost exclusive dealings with its clients throughout the Northern Cape.
The court dismissed the contention that it would be unreasonable to enforce the restraint, because Mr Duraan had been dismissed by Freepak. It was clear from the terms of the restraint that it would be triggered after any form of termination of employment.
The court therefore enforced the restraint against the Duraans, restraining each of them for two years from the date of termination of their employment from being involved in any other business selling similar products as Freepak in the Northern Cape.