Restraining non-compete restraints - Is there a case for regulating restraints of trade in Australia?

Governments around the world are increasingly seeking to regulate the use by employers of non-compete restrictive covenants. On 23 April 2024, the US Federal Trade Commission announced that non-compete clauses would be prohibited, and they are already considered void in some US states for employees below certain income levels or in certain industries. Restrictions on the length of restraints have been mooted in the United Kingdom and some EU countries limit the use of restraints for some income levels, or mandate compensation for the duration of restraints.

For its part, the Australian Government, through its Competition Review Taskforce, has recently released an Issues Paper for consultation on the use of post-employment restraints of trade in Australia. The Issues Paper explores reform options to address perceived issues with labour mobility and wage growth, said to be caused by limiting workers from freely moving to a competitor (and enticing their fellow employees to do the same) through the offer of higher salaries, as identified in the Australian Government’s 2023 Employment White Paper on Jobs and Opportunities.

The Issues Paper identifies ABS data that 46.9 per cent of Australian businesses use some type of restraint clause, and this occurs across all industries and all business sizes. The main types of restraints of trade are non-compete clauses, non-solicitation clauses, non-poach clauses, and non-disclosure clauses.

What are post-employment restraints of trade?

Post-employment restraints of trade are contractual obligations (contained in the contract of employment, or in related documents) ordinarily limited by a specific period post-employment. They generally come in the following forms:

‘non-compete’ obligations – which prohibit employees from working or providing services to competitors of their former employer. These obligations protect an employer’s commercially sensitive trade secrets, goodwill and investment in their employees. According to the ABS, around 20.8 per cent of businesses used a non-compete clause for some of their workers in 2023. The Issues Paper identifies non-compete obligations as the key policy challenge.
‘non-solicit’ / ‘non-dealing’ obligations – which prohibit employees from soliciting, dealing or interfering with the customers, and/or clients and suppliers of their former employer. These obligations protect the value in employers’ relationships with their customers, clients and suppliers. According to the ABS, around 25.4 per cent of businesses used a client non-solicitation clause for some of their workers in 2023.
‘non-poach’ obligations – which prohibit employees from enticing or hiring the employees of their former employer. These obligations protect an employer’s investment in a well-trained and stable workforce. According to the ABS, around 18 per cent of businesses used a co-worker non-solicitation clause for some of their workers in 2023.

In addition to the obligations above, employees are bound by either an express contractual or common law obligation which restricts them from revealing confidential information they have collected throughout their employment to a competing business, or using that information for the benefit of that business. The intention behind confidentiality obligations is to protect proprietary information from being used by a worker to benefit a competing business. Employees are also subject to confidentiality obligations in the Corporations Act 2001 (Cth). Confidential information could include trade secrets, client lists, product formulas, or other types of information that can support business development for competitors. The Issues Paper considers confidentiality clauses to be the mostly commonly used ‘restraint’ in 2023, with the ABS recording that 45.3 per cent of businesses used a non-disclosure clause for some of their workers in 2023.

Business sale restraints of trade

Employment contracts are not the only place individuals can be bound by restraints of trade. It is common for business sale agreements, shareholders’ agreements and equity incentive plans to restrain parties to the agreement (including founders, senior executives and other employees with equity interests in the business). The commercial basis for restraining these classes of individuals in a business sale context differs from post-employment restraints, in that it is designed to (among other things):

restrain former owners of a business from using their knowledge of the business’ commercially sensitive trade secrets to operate a new business in competition with the business they sold, to ensure the protection of the goodwill of the business being acquired by the purchaser; and
restrain former owners from poaching key employees of the business they sold.

In a private equity context, business sale restraints are crucial to ensure that key executives and ‘founders’ are retained by the business post-completion, as it is often the case that those individuals have knowledge of (or are the ‘face’ of) the business and their departure would significantly devalue the entity.

In the contexts above, business sale restraints of trade are crucial to protecting the goodwill and giving the purchaser of a business or the remaining shareholders the full value of the business they are acquiring.

In the Issues Paper, the Australian Government is silent on its position on the use of restraints of trade in a business sale context. The difficulty with the Australian Government’s silence on this issue is that there are restraints that “cross-over” between business sale and post-employment contexts. For example, if a senior executive holds a substantial but minority equity interest in a company, through a shareholders’ agreement or equity incentive plan, they may be restrained from competing against the business they managed from the time they cease to hold an equity interest in the company – which can coincide with the cessation of their employment. The absence of a position from the Australian Government places significant uncertainty on these kinds of restraints of trade to the extent they are relevant to business sale transaction and equity incentive plans.

By contrast, the position of the Federal Trade Commission in the United States is clear: “The final rule does not apply to non-competes entered into by a person pursuant to a bona fide sale of a business entity.” The FTC’s rule is similar to the older prohibition in California which also excluded business sale non-compete obligations from the broader prohibition.

The current regime for resolving post-employment restraint issues

With the exception of the common law position in NSW, which has been modified by statute, post-employment restraint obligations are governed by the common law restraint of trade doctrine and contract law. Under this regime, post-employment restraints are presumed unenforceable unless the employer can demonstrate they are reasonably necessary to protect a legitimate business interest, or the employee can show it is otherwise against the public interest.

The reasonableness of the restraint of trade clause is determined by courts on a case-by-case basis. Where an employer is unable to justify either the restraint obligation or the extent of its operation (period or area of operation), the restraint is deemed void and not enforceable. The position on restraints of trade in NSW under the Restraints of Trade Act 1976 (NSW) renders restraint of trade obligations enforceable to the extent they do not conflict with public policy. The legislation provides the Courts with the power to ‘read down’ restraint obligations to what is reasonable.

The common law also permits a court to ‘sever’ part of a restraint clause where the offending part can be severed from the other restraint obligations. The effect of this is that employers often draft ‘cascading’ or ‘waterfall’ restraint periods (e.g., 12, 9 and 6 months) and geographical areas (e.g., Australia, NSW, Sydney) to increase the prospect that at least part of the restraint will be enforceable.

The strawman case against post-employment restraints

The Issues Paper identifies several alleged issues with the current post-employment restraint regime:

Possible reform responses

In his McKell Institute Address, Minister Leigh, referred to former Fair Work Commission President Dr Iain Ross’s March 2024 Working Paper, discussing the case for a regulatory response to non-compete clauses in employment contracts. The Working Paper explores potential reform options in the Australian context, which we consider could form part of potential regulatory responses in future:

What’s next?

The Australian Government looks likely to introduce some form of reform to post-employment restraints either in this term of Parliament, or the next (assuming re-election). The Competition Review Taskforce is seeking submissions responsive to its Issues Paper by 31 May 2024. The Taskforce will advise Government on possible reform options before the end of 2024.

In advance of any potential reforms, employers may wish to consider now how to best ‘future-proof’ their methods of protecting commercially sensitive and proprietary trade secrets and key business relationships. Initial considerations could include:

evaluating alternative protections, such as extended notice periods and garden leave provisions (i.e., directions to stay at home and not access the employer’s confidential information during their notice periods).

developing or expanding remuneration programmes that are more focussed on retention (i.e., moving to focus on the ‘carrot’ of remuneration to retain employees rather than the blunt ‘stick’ of a contractual restraint);

reviewing the current application of non-competes across the workforce to identify areas of the most concern and ensure a defensible rationale for application;

where cascading clauses are in place, assessing which areas (geographic and commercial) are of the most concern and would most require protection in a non-cascading, targeted restraint; and

for multi-jurisdictional employers, evaluating to what extent sensitive information or critical relationships are exposed to the Australian workforce.

Please get in touch with us if you would like to discuss the impact of possible reforms in this space.

ISSUES PAPER IDENTIFIED PROBLEM	POTENTIAL CONTRARY VIEW	Example uses 2
The central mischief - The key problem identified in the Issues Paper is that post-employment restraints restrict labour mobility, depress wages, constrain competition, innovation and economic growth. This is because restraints have a ‘chilling effect’ on employee behaviour by dissuading them from seeking alternative employment for higher remuneration.	Limited evidence is presented in the Issues Paper justifying the position that post-employment restraints restrict labour mobility and depress wage growth. For example, US studies are cited that identify limited correlations between jurisdictions that ban non-compete clauses and enhanced job mobility and wage growth. The difficulty with such studies is they do not causally identify the prohibition of non-compete clauses as the reason for enhanced job mobility and wage growth. For example, the Issues Paper suggests there is high job mobility and wage growth in California but does not provide any empirical evidence to sustain this conclusion. Similarly, the Issues Paper cites records indicating that labour mobility across Australia has dwindled over the past 30 years and suggests that this could be because restraints of trade are preventing workers from switching jobs. No causal evidence is presented to justify this suggestion. We also note that the Issues Paper relies on international examples from dominate economies, such as the US, where there is existing regulation of non-compete obligations (e.g. in California). In contrast, a ban or limit on non-competes would make Australia a significant outlier from its regional Asia Pacific peers such as Hong Kong, Singapore and Japan and a less attractive destination innovative businesses (and foreign investors) seeking to develop new technologies.
Statistics - The Issues Paper heavily relies on ABS statistics concerning the proliferation of post-employment restraints by Australian businesses to create a case that restraint of trade obligations are used indiscriminately by employers throughout Australia.	The ABS statistics used in the Issues Paper consider where a business uses a particular restraint obligation (e.g., 20.8 per cent of businesses used a non-compete clause for some of their workers in 2023). While the ABS statistics do suggest that the employers who use post-employment restraints do so for most of their employees (76-100 per cent), they do not record the specific positions that the restraints apply to, the salary level of the employees bound by restraints, the type of restraint applied, or the extent to which post-employment restraints are enforced by employers. The statistics also indicate that large businesses (1000+ employees) had the highest use of non-compete clauses whereas small businesses (0-19 employees) had the lowest use of non-competes. The ABS statistics do not meaningfully contribute to the policy discussion concerning whether contractual post-employment restraints are being abused to the detriment of employees. Curiously, despite noting the prevalence of post-employment restraints in employment contracts, the Australian Government ignores other statistics that indicate 53.8 per cent of employers are unsuccessful at enforcing post-employment restraints. If NSW is excluded, employers are successful in only 1 in 3 cases. These statistics derive from a study which observed that over a 23-year period, Australian Courts enforced restraints in only 78 (of 145) judgments – or a little over 3 judgments per year. Given the apparent prevalence of restraints (based on ABS statistics) that is a strikingly low enforcement rate.
Uncertainty of enforcement and the “chilling effect” of restraints – The Issues Paper suggests that the use of post-employment restraints in Australia is skewed in favour of employers in the following respects: the use of cascading restraint periods and areas means that employees do not know if restraints are enforceable, or for how long they are bound by restraints; post-employment restraints are not negotiated by employees because of a power imbalance in the relative bargaining positions of employees versus employers; and post-employment restraints are used indiscriminately across all employees.	It does not follow that the use of cascading restraint periods and areas means employees are confused about whether their post-employment restraint obligations are enforceable, and for how long. A properly drafted restraint will make clear that each restraint period/area can be enforced, and that the parties intend for the maximum restraint period and area to apply. The real policy question is: which branch of government is best able to regulate any perceived market failure of post-employment restraints (assuming that premise is accepted)? In a speech accompanying the release of the Issues Paper, the Hon Dr Andrew Leigh MP, Assistant Minister for Competition, Charities and Treasury, and for Employment suggested that changes to the law on employment constraints (to the extent agreements on those restraints are made between competitors) could be dealt with in the Competition and Consumer Act 2010 (Cth), which is enforced by the Australian Competition and Consumer Commission. The Issues Paper does not say anything further on the regulator’s potential role. The Issues Paper alleges the judiciary is not best placed to regulate the perceived mischiefs because no clear common law rules on restraint enforcement have developed, and enforcement is determined on a case-by-case basis. However, there is a limited basis to believe that (and the Issues Paper does not justify why) a case-by-case assessment of ‘reasonableness’ by the courts is less fair than a uniform statement of law in a statute. Clearly, the indiscriminate use of post-employment restraints for junior employees or employees who do not have access to their employer’s commercially sensitive trade secrets and business relationships is excessive. This may be particularly so where those types of employees have limited bargaining power.

POTENTIAL DETAILS	INDIVIDUAL	Example uses 2
DEGREE OF REGULATORY INTERVENTION: Low Monetary thresholds To remedy the application of non-compete restraints that have been applied to ‘low-wage’ employees, a possible response is to prohibit non-compete provisions for employees earning below the high-income threshold (indexed annually on 1 July - currently at $167,500), or for persons covered by a modern award. This would mirror the approach adopted by the US Federal Trade Commission (which has an exception for ‘senior executives’ with incomes above USD 151,164 whose existing non-compete obligations will be grandfathered), as well as the position in some European countries such as Germany and Luxembourg. The weakness with this regulation is that an employee earning less than $167,500 may still possess commercially sensitive trade secrets of their employer and have business relationships with key clients / suppliers. A uniform income-based bar to restraint may result in reasonable restraints being unenforceable. Similarly, many award-covered employees – particularly those covered by the Banking, Finance and Insurance Award 2020 – operate in senior and sensitive positions where access to commercially sensitive trade secrets and business relationships is common and could be used against former employers. Restraint limitations and payment for restraints A possible regulatory response is: limiting the duration of non-compete and non-solicit clauses to a maximum period (e.g., up to 6 months); or requiring that the worker subject to the non-compete be compensated by their employer for the duration that the non-compete clause applies. This approach is currently adopted in some European jurisdictions (e.g., Germany and Poland) and addresses the concern that employees will be rendered unable to earn an income for a period post-employment.
DEGREE OF REGULATORY INTERVENTION: Moderate Banning some restraints Dr Ross’ Working Paper argues that particular restraints, such as non-compete clauses, should be banned. The basis of this position is that non-compete restraints are the most burdensome on employees and restrict job mobility. The risk with this approach is that absent being ‘held out of the market’, it is practically difficult for former employers to determine whether their former employees are utilising commercially sensitive proprietary information with their new employer. This is the approach adopted by the US Federal Trade Commission, excluding existing senior executive’s non-compete obligation entered into before the FTC’s new rule. Regulating common law severance principles The Australian Government could prohibit ‘cascading’ style restraints which provide for alternate obligation periods and areas. In other words, restraints in an employment contract could be restricted to a single period and area. This would address any concern that, where cascading restraints are used, employees are unable to understand what restraint they are bound by. This approach is the current UK approach to post-employment restraint interpretation.
DEGREE OF REGULATORY INTERVENTION: High Banning all post-employment restraint obligations While we consider this an unlikely approach given the inevitable pushback this would face from employers, this is a potential option that could be explored. There is international precedent for this option. For example, the State of California prohibits the enforcement of all non-compete restraints (except in a business sale context).