Restraint Clauses in Australia: Changes on the Horizon

Restraint clauses in employment contracts, such as non-compete, non-solicitation, and non-disclosure clauses, may become a hot topic in Australia. The Competition Task Force of the Treasury released an Issues Paper titled “Non-competes and other restraints: understanding the impacts on jobs, business and productivity” on 4 April 2024, emphasising the significant implications for businesses and employees. These clauses, designed to limit what an employee can do after leaving a company, have sparked debate over their fairness and impact on job mobility, wages, and innovation.

The comments in the Issues Paper relate to restraint clauses for employees and independent contractors.

The Issues Paper was open for submissions to be made until 31 May 2024. This relatively short period has obviously now expired. Submissions were made by groups such as the Australian Industry Group and the Australian Chamber of Commerce and Industry. 

From the tone and comments in the Paper, it would seem likely that the writing is on the wall for changes to be made in Australia to the law relating to restraint clauses.

NCP consultation paper

On 24 August 2024, the Treasurer of Australia, Jim Chalmers, together with the Treasurer of New South Wales, Daniel Mookhey, issued a press release titled “Next step to revitalise National Competition Policy”. In this release, they state that the Australian and State and Territory governments have released a further consultation paper seeking feedback on how to modernise the National Competition Policy (NCP).

This new Consultation Paper contemplates a wide-ranging review of the NCP and commences with an observation that Australia’s productivity growth has slowed over the past decade and that competition is essential for lifting dynamism and productivity, supporting sustainable real wages growth, putting downward pressure on prices, and delivering more and better choices for Australians.

The Paper contemplates three competition reform themes. Reform theme 3 is Lowering barriers to labour mobility, and it notes actions suggested by previous work to include:

• The House of Preventative Standing Committee on Economics asked the government to consider the appropriateness of constraints and bans on non-compete clauses and other restraint of trade clauses.

This was a reference to the House of Representatives Standing Committee on Economics, Better Competition, Better Prices: Report on the enquiry into promoting economic dynamism, competition and business formation (Parliament of Australia 2024).

Submissions were required to be made to Treasury on the Consultation Paper by Monday, 23 September 2024.

What are restraint clauses

Restraint clauses are contractual agreements that can restrict an employee’s actions after leaving a company. The most common types are:

1. Non-compete clauses: These prevent former employees from working for competitors or starting a competing business within a certain geographic area and time period after leaving a company.
2. Non-solicitation clauses: These clauses restrict former employees from soliciting clients, customers, or colleagues from their former employer.
3. Non-disclosure clauses: These ensure that former employees do not share confidential information gained during their employment, such as trade secrets or client lists.

Why do businesses use restraint clauses?

Courts have found that restraint clauses are essential for protecting businesses and their legitimate interests. For example, non-compete clauses help safeguard intellectual property, customer relationships, and investments in employee training. By preventing employees from taking their knowledge and skills directly to competitors, businesses can protect their competitive advantage.

However, the effectiveness and fairness of these clauses are increasingly being questioned, especially when applied broadly or to low-wage or workers in non-executive roles. The balance between protecting business interests and allowing employee mobility and economic freedom to workers and customers is delicate, and the current legal framework in Australia and other countries reflects this tension.

The Australian legal landscape compared to other countries

In Australia, the enforceability of restraint clauses is generally governed by common law, with courts scrutinising whether a clause is reasonable and necessary to protect legitimate business interests. If a restraint is not reasonable, it will be void under common law. However, the rules can vary slightly depending on the state. For instance, New South Wales’s Restraints of Trade Act 1976 allows courts more flexibility to modify and enforce restraint clauses than in other states.

Comparatively, other countries are also grappling with how to handle these clauses:

• United States: In the U.S., the enforceability of non-compete clauses varies widely by state, with some states, like California, banning them altogether while others enforce them more strictly. There is growing momentum at the federal level to impose restrictions on these clauses, especially for lower-wage workers, to enhance job mobility and competition.
• United Kingdom: The UK has a more regulated approach, with courts closely scrutinising the reasonableness of restraint clauses. Recently, there have been discussions about reforming the use of non-compete clauses, particularly in light of concerns about their impact on job mobility and innovation.
• Germany and Austria: These countries have stricter regulations, limiting the enforceability of non-compete clauses unless certain conditions are met, such as providing financial compensation to the employee during the restricted period.
• Finland: Finland also imposes limitations on non-compete clauses, requiring them to be justified by a specific business need and often necessitating compensation for the restricted period.

Australia’s approach sits somewhere in the middle of these international perspectives. While restraint clauses are generally enforceable if deemed reasonable, there is a growing sentiment about the need to balance business interests with the rights of employees to seek better opportunities. Given that – as reported in the Issues Paper – when restraint clauses have been challenged Australia-wide (excluding NSW), employers were unsuccessful in 66.7% of cases. Within that 66.7% of unsuccessful restraint clauses, 78.6 % of them were found to be invalid. The legislature likely sees a problem that employers are attempting to enforce restraint clauses that are either not applicable or completely unenforceable. 

The challenge of ladder or cascading clauses

One of the more complex and controversial aspects of restraint clauses in Australia is the use of ladder or cascading clauses. These clauses are designed to include multiple overlapping or cumulative restraints, such as varying geographic areas, time periods, or restricted activities. The idea is that if a court finds one part of the clause unreasonable, it can sever that part while still enforcing the remainder. These clauses are often included because of the difficulty, particularly at the commencement of a contract or period of employment, of determining what will be reasonable in the future.

While this approach might seem pragmatic from a business perspective, it creates significant uncertainty for employees. The broad scope of cascading clauses often means that employees are left unsure about which parts of the restraint might be enforceable and are thus more likely to comply with the broadest, most restrictive terms out of caution. The Issues Paper asserts that this uncertainty can have a chilling effect on job mobility, as employees may hesitate to pursue new opportunities for fear of violating a clause that could be enforced against them.

The cost of litigation and its impact on job mobility

Another critical issue is the cost of litigation. The financial burden can be significant for employees wishing to challenge the enforceability of a restraint clause. The costs associated with legal action, including the potential need to engage barristers and the risk of facing an injunction, can be prohibitive. This financial hurdle often deters employees from challenging even clearly unreasonable restraint clauses, leading many to simply abide by them despite their doubts.

Furthermore, the use of cascading clauses and the potential for costly litigation adds to the power imbalance between employers and employees. Employers, often more familiar with legal processes and better resourced, can use the threat of litigation as a tool to enforce broad restraint clauses. This dynamic can restrict employees’ bargaining power, limit their career options, and stifle job mobility across the broader economy.

What's on the horizon?

The future of restraint clauses in Australia is uncertain, with potential reforms on the horizon. The introduction to the Issues Paper states:

On 23 August 2023, the Australian Government announced that non compete and related clauses in employment contracts would be an area of policy considered by the Competition Review. The Government’s Employment White Paper Roadmap, released in September 2023, reiterated the Government’s intent to investigate non compete clauses, and noted emerging research that non compete clauses may be restricting workers from switching to better paying jobs and hampering job mobility and innovation. There is empirical evidence linking lower rates of job mobility with reduced productivity growth, both in Australia and across the OECD^[1].  Labour mobility is also particularly important for managing structural changes in our economy, including the transformation to net zero and the shift to the care economy^[2]. 

There is growing international evidence that restraints of trade – and particularly non compete clauses – are becoming increasingly prevalent. This evidence also suggests that despite benefiting some businesses, restraint of trade clauses are adversely impacting workers, other businesses and broader economic outcomes – through reduced wages growth, job mobility, and access to skilled workers. Some countries already regulate non compete clauses (e.g. Austria, Finland and Germany), while others, including the United States (US) and United Kingdom (UK), are proposing reforms that would restrict or ban their use.

Possible amendments could include stricter legislative or regulatory regimes that will bring us more in line with our European cousins, especially for lower-wage workers, or more precise definitions of what constitutes a reasonable and enforceable restraint, especially given the high rate of failure when challenged. Businesses may need to reconsider the necessity of these clauses in their contracts and whether alternative methods can achieve the same protections without limiting employee mobility.

Considerations for businesses and employees

As possible amendments are uncertain, businesses should review their restraint of trade clauses and ensure that any restraints are reasonable. This includes reviewing subject matter, time, and geographical restraints in the clauses. 

A periodic review of contracts and restraint clauses may mean that it is not necessary to include ladder clauses to take account of changing circumstances.

For employees, understanding the implications of these clauses before signing an employment contract is vital. Seeking legal advice can help clarify what these clauses mean and how they might impact future career opportunities.

While restraint clauses can play a role in protecting businesses, their broad application, the use of cascading clauses, and the associated litigation risks are under increasing scrutiny. As Australia considers possible reforms, it will be essential to strike a balance that protects both businesses and workers in a rapidly changing economic landscape.

If you are worried that your standard contracts contain restraint clauses that may cause an issue or believe that your employment restraint clauses are too restrictive or not effective enough, please don’t hesitate to contact us for expert advice.