By James Carnie and Anna Shackell
The investment of time and money in training new staff is an outlay that employers seek to protect and benefit from. Obviously it is not good for business if an investment gives no returns and, worse still, if that investment in human capital is applied in the establishment of competition (e.g. a former employee setting up a competitive business in the same vicinity using the knowledge and skills obtained during their former employment). In order to safeguard from this (albeit temporarily), employment contracts commonly have restraint of trade (“ROT”) clauses.
Traditionally ROT clauses have included promises:
- Not to join or assist a competitor; and
- Not to solicit the former employers customers; and
ROT clauses vary as to the duration of the ROT, the geographical area covered, and the particular actions prohibited.
ROT clauses have commonly been ruled unenforceable or invalid by the Courts. However, the recent Court of Appeal decision in Fuel Espresso Ltd v Victor (Chi-Huan) Hsieh  NZCA 58 has provided a significant boost to the validity of ROT contractual arrangements and the “sanctity of contracts” made.
ROT clauses will be upheld and enforced by the Courts provided that the employer has a sufficient business interest to protect, the restraint is reasonable in the circumstances and valuable consideration is given for the restraint.
Fuel Espresso Ltd (“Fuel”) operates 10 coffee carts and espresso outlets in Wellington City. Fuel offers training programmes to employees where they learn the coffee and barista trade as well as the way Fuel’s business is run. Fuel’s employment agreement contains a ROT clause that prevents an employee from working in a competing espresso bar, café or coffee company for three months after termination of their employment. The ROT is geographically limited to:
- a 100m radius of a Fuel operation in the case of other employment; or
- a 5km radius if the employee is setting up a competing business
Victor Hsieh was a barista for Fuel and on 7 January this year, he resigned his employment. On 15 January he began working at a competing coffee cart situated 70m away from a Fuel outlet. In February, Fuel applied for an interim injunction against seeking orders that Hsieh cease working for or operating the coffee cart until on or after 7 April 2007. The basis of the claim was that Hsieh had breached the ROT clause in his employment agreement.
EMPLOYMENT COURT DECISION
The Employment Court applied the usual tests that apply in an application for an interim injunction relating to a restraint of trade:
(a) Is there an arguable case as to the enforceability of the ROT; and
(b) Whether the balance of convenience favours one side or the other.
The Court determined that the principal issue was whether or not the restraint of trade clause was enforceable and noted that there were three aspects of enforceability:
- Are the terms of the ROT enforceable? The Court found that they were not too wide and were confined to areas around Fuel operations and as such were enforceable;
- Does Fuel have a proprietary interest that needs to be protected? The Court found that there was an arguable case that there was an interest in Fuel customers in a small area where they come to get their coffee, which could be taken by a competing business. This was arguably a proprietary interest to protect.
- Has there been any consideration? It was on this point that the employer’s argument failed in the Employment Court. The Court noted that valuable and legal consideration was a prerequisite for an enforceable restraint of trade.
The Court observed that Hsieh was paid the basic wage for a café employee and there was nothing in his employment agreement that showed he was paid anything more for the restraint.
The Court held that “the law is that if you are going to require an employee to be restrained there must be some extra payment for that”.
Consequently, the restraint of trade was held to be unenforceable and therefore, an injunction could not support it.
Less than three weeks after the decision of the Employment Court, the parties were before the Court of Appeal. The question before the Court of Appeal was whether there had been consideration for the restraint of trade.
COURT OF APPEAL DECISION – “AGREEMENTS ARE MADE TO BE KEPT”
The Court observed that the Employment Court appeared to have relied on M A Watson Electrical v Kelling  1 ERNZ 9 for the proposition that “extra payment” was required for the restraint of trade. However, the Court pointed out that in that case, a ROT clause was inserted into an employment agreement after the employee had been working for the employer, and by reasons of the particular facts of the case, it was held that there was no consideration for the ROT. Therefore Hsieh’s situation was very different as the ROT clause had been in his employment contract from the beginning of his employment.
The Court noted that consideration requires that there be something of value to be given, and is either some detriment to the promise (in this case the employer) or some benefit to the promisor (in this case the employee). The Court found that “the law does not enquire into the adequacy of the consideration, nor, as the Judge seems to have thought, does it require an extra “premium” for a restraint of trade clause”.
Consequently, the Court of Appeal held that not only was there an arguable case for consideration, but in this instance, there was consideration.
The Court then went on to consider the balance of convenience question and made the important statement that “Agreements are made to be kept”. It further observed that Mr Hsieh was employed and trained, but then left and undertook an activity which a clear contractual provision prevented him from doing. The Court held that in the absence of an interim injunction, any relief to Fuel would be nugatory.
Accordingly, the Employment Court decision was overturned and the interim injunction allowed, preventing Mr Hsieh from working at the coffee cart until after 7 April 2007.
LESSONS TO BE LEARNT
For a ROT to be enforceable, it must be reasonable. The Court of Appeal commented that the adequacy of the consideration might be relevant to whether a restraint is reasonable in more extreme situations. For example, a low salary, set against a harsh restraint was said to be relevant to the exercise of the Court’s discretion.
Separate consideration is not necessarily required for a ROT to be enforceable. However, where the employer seeks to introduce a ROT as a new term in an employment agreement (after employment has commenced), identifiable consideration will be necessary.
An important aspect of the Court of Appeal decision was its statement that “Agreements are made to be kept”. This provides some welcome support to the time-honoured concept of the sanctity of contract and strengthens the argument for the enforceability of a ROT that is agreed between the parties.
The reasonableness of an ROT also depends upon:
- The activity/s to be restrained;
- The geographical limits;
- The length of the restraint period;
- Whether a restraint is appropriate to protect a particular business interest;
- The nature of the former employee’s job; and
- The inability to obtain other work
There are a number of factors to consider when preparing a ROT clause. While ROT clauses are an important tool used by employers to protect various aspects of their business, the clauses should be carefully drafted to ensure that they will be enforceable should the need arise.
James Carnie is the Principal, and Anna Shackell a Solicitors at Clendons