Two recent cases have provided valuable guidance on the enforceability of restraint of trade obligations against former employees in contracts for the sale of a business. The cases make it clear that considerable latitude is applied by the courts to protect the buyer’s purchase of goodwill where commercial interests are involved, but also that there are important limitations employers and other buyers of a business need to be aware about.
In a recent Victorian Supreme Court case, the court considered restraints arising from a share sale agreement made between an owner and key employee of Southern Cross Computers Pty Ltd (Southern Cross), Mr Palmer, who sold his 40% shareholding in the business to Ingenio Group Pty Ltd for $3.5 million on 28 June 2016. A key term of the share sale agreement was a non-compete restraint clause which, when read to its full extent, restricted Mr Palmer from competing in a business providing IT procurement and associated IT managed services in Australia for 4 years from the date the transaction completed.
McDonald, J held that the 4 year non-compete restraint was reasonable because:
The judge found that there is nothing exceptional in a four year non-compete restraint in the context of a goodwill case where the vendor receives a substantial amount of consideration and referred to three other cases involving commercial transactions where restraints of 5 and 10 years had been upheld. However, in terms of defining the type of business Mr Palmer could not compete against, it was important to restrict its application to the goodwill of the business that existed at the time the transaction completed so that it did not apply to areas of the business that had developed and grown since that time.
This means that non-compete restraints may not be enforceable if they attempt to cover business outside the scope of that which is being purchased at the date the commercial transaction is concluded. That is because the test of reasonableness of a non-compete restraint in the context of a share sale agreement is focused on what is necessary to protect the goodwill in the business that has been sold to the purchaser. A general non-compete restraint that extends to business developed outside the scope of the purchased business may not be reasonable and may not therefore be enforceable.
This principle was confirmed in another recent decision involving a non-compete restraint contained in a share sale agreement between Mr Goldstein and Freedom Finance Accounting Pty Ltd (Freedom Finance) in the Supreme Court of Victoria.
Freedom Finance entered into a share sale agreement to purchase Mr Goldstein’s 50% shareholding in Goldstein Farrell, an accounting firm for $358,500 on 10 February 2015. The share sale agreement contained restraints preventing Mr Goldstein from providing “accounting services” and “non-accounting services” for 3 years from 1 May 2015. Mr Goldstein continued to work for Goldstein Farrell until he resigned from his employment almost 2 years later. Mr Goldstein then commenced working for a small accounting firm in another suburb. However, the share sale agreement failed to confine the non-compete restraint solely to the accounting services business that was the subject of the transaction and the non-compete restraint was found to be unenforceable.
The court found that the definition of “accounting services” was far too wide, in that it referred to financial services of a type which Mr Goldstein never provided to his clients at the time of the transaction. The share sale agreement also attempted to restrain Mr Goldstein from providing “non-accounting services”, which was framed by reference to his activities after the transaction completed and the agreement had no reference to the purchased goodwill. McDonald J concluded that even if the ‘non-accounting services’ could be severed, it would not cure the invalidity because the definition of “accounting services” was also too wide. The restraint was also unreasonable in geographic scope because Freedom Finance was not able to prove that as at the time of the transaction Goldstein Farrell had clients throughout Victoria as no client list was annexed to the share sale agreement.
These cases are an important reminder of the benefits of non-compete restraints in the terms of any agreement to purchase a business to ensure that the buyer gains the full benefit of its purchase of goodwill. However, as is always the case, it is important to carefully consider how these restraint clauses are drafted. In particular: