Supreme Court New South Wales Medium Neutral Citation: Provida Pty Limited v Sharpe [2012] NSWSC 1041 Hearing dates: 27 and 28 August 2012 Decision date: 29 August 2012 Jurisdiction: Equity Division Before: Pembroke J Decision: See paragraphs [31] - [32] Catchwords: CONTRACT - employment - restraint of trade - "directly or indirectly" - providing services through newly established company - company is "one-man band" with short history - overall context and evident purpose and object of "trade in competition" - phrase "indirectly" covers circumstances of defendant's close connection with new company CONTRACT - employment - restraint of trade - legitimate interest - protection of confidential information - severance of connection between defendant and clients of plaintiff CONFLICT OF LAWS - proper law of contract - closest and most real connection - place of formation of contract only one factor determining applicable system of law - location of head office of employer influential STATUTORY INTERPRETATION - Competition and Consumer Act 2010 (Cth) - cartel provisions and restraints of trade - s 51(2)(b) exception - evident purpose to protect restraints on trade in employment contracts Legislation Cited: Competition and Consumer Act 2010 (Cth) Restraints of Trade Act 1976 Cases Cited: Arthur Murray Dance Studios of Cleveland Inc v Witter (1952) 105 NE (2d) 685 Baltic Shipping Co v Dillon [1991] NSWCA 19; (1991) 22 NSWLR 1 Bonython v Commonwealth [1951] AC 201 Buckley v Tutty [1971] HCA 71; (1971) 125 CLR 353 Cactus Imaging Pty Ltd v Peters [2006] NSWSC 717; (2006) 71 NSWLR 9 Cooney v Council of the Municipality of Ku-ring-gai [1963] HCA 47; (1963) 114 CLR 582 Curro v Beyond Productions Pty Ltd (1993) 30 NSWLR 337 Dewes v Fitch [1920] 2 Ch 159 Harlow Property Consultants Pty Ltd v Byford [2005] NSWSC 658 Herbert Morris Ltd v Saxelby [1916] 1 AC 688 Kearney v Crepaldi [2006] NSWSC 23 Koops Martin Financial Services Pty Ltd v Reeves [2006] NSWSC 449 Lindner v Murdock's Garage [1950] HCA 48; (1950) 83 CLR 628 Linwar Securities Pty Ltd v Christopher Savage [2006] NSWSC 786 Littlewoods Organisation Ltd v Harris [1977] 1 WLR 1472 Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC 535 Oceanic Sun Line Special Shipping Co Inc v Fay [1988] HCA 32; (1988) 165 CLR 197 Seven Network (Operations) Ltd v Warburton (No 2) [2011] NSWSC 386 Toll (PGCT) Pty Ltd v Alphapharm Pty Ltd [2004] HCA 49; (2004) 219 CLR 165 Woolworths Ltd v Olson [2004] NSWCA 372 Wright v Gasweld Pty Ltd (1991) 22 NSWLR 317 Category: Separate question Parties: Provida Pty Limited - plaintiff Ashley Sharpe - first defendant ITW Australis Pty Limited - second defendant CFCL Australia Pty Limited - third defendant Magni Pty Limited - fourth defendant Representation: Counsel: F Corsaro SC - for the plaintiff R W Tregenza - for the first defendant Solicitors: Proctor Phair Lawyers - for the plaintiff BTF Lawyers - for the first defendant Clayton Utz - for the second defendant Allens - for the third defendant Muir Lawyers - for the fourth defendant File Number(s): 2012/142996 EX TEMPORE Judgment Introduction 1The first defendant is a former employee of the plaintiff. He contests the validity of certain restraints contained in his employment contract. The restraints are as follows: 16(b) While you are employed by Provida (and for a period of 2 years after the termination of employment) you must not do any of the following, directly or indirectly: - ... - Solicit or persuade any person or entity who has dealt with Provida during the 12 months prior to the termination of your employment or is in the process of negotiating with Provida at the time of the termination of your employment in relation to any business carried on by Provida, to cease doing business with Provida or reduce the amount of business which the person or entity would normally do with Provida; - Trade in competition to Provida Pty Ltd for a period of 2 (two) years after cessation of employment. Legal Principles 2The legal principles which govern the resolution of the issues in this case are well known. The general policy of the law is that people should honour their contracts: Baltic Shipping Co v Dillon [1991] NSWCA 19; (1991) 22 NSWLR 1 at 9 (Gleeson CJ); Seven Network (Operations) Ltd v Warburton (No 2) [2011] NSWSC 386 at [3]. It does not matter if the employee may have misunderstood or overlooked the terms of the contract to which he is bound. The enforcement of a commercial contract does not depend on a party's knowledge or understanding of its terms: Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd [2004] HCA 49; (2004) 219 CLR 165 at [43] - [44]. 3There are some qualifications to the general principle that contracts are meant to be observed. Covenants imposing a restraint on an employee's trade and covenants against solicitation of clients will not be enforced if the restraint is not necessary for the reasonable protection of the legitimate interests of the employer: Buckley v Tutty [1971] HCA 71; (1971) 125 CLR 353 at 376; Curro v Beyond Productions Pty Ltd (1993) 30 NSWLR 337 at 344. Restraints of trade, including restraints on solicitation of customers, will only be upheld when they are reasonably necessary to prevent, among other things, the disclosure of confidential information obtained by the former employee in the course of employment or the exploitation of a connection built up by that employee with the employer's customers in the course of that employment. 4There are several subsidiary principles that should also be mentioned: (a) First, the court gives considerable weight to what parties have negotiated and embodied in their contract but a contractual consensus is not conclusive even when there is a contractual admission as to reasonableness: Woolworths Ltd v Olson [2004] NSWCA 372 at [39]; Seven Network at [70] - [71]. (b) Second, the validity of the restraint is to be tested at the time of entering into the contract and by reference to what the restraint entitled or required the parties to do rather than what they intended to do or have actually done: Woolworths at [40]. (c) Third, the test of reasonableness is measured by reference to the interests of the parties concerned and the interests of the public. The requirement that the restraint be reasonable in the interests of the parties means that the restraint must afford no more than adequate protection to the party in whose favour it is imposed: Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co Ltd [1894] AC 535; Herbert Morris Ltd v Saxelby [1916] 1 AC 688 at 707; Buckley v Tutty at 376; Linwar Securities Pty Ltd v Christopher Savage [2006] NSWSC 786 at [25]-[26] (Nicholas J); Koops Martin Financial Services Pty Ltd v Reeves [2006] NSWSC 449 at [28] (Brereton J). (d) Fourth, an employer is not entitled to require protection against mere competition. Covenants that restrain competition are invalid unless they are reasonably necessary to protect the legitimate business interests of the employer: Dewes v Fitch [1920] 2 Ch 159 at 181; Wright v Gasweld Pty Ltd (1991) 22 NSWLR 317 at 329 (Gleeson CJ); Harlow Property Consultants Pty Ltd v Byford [2005] NSWSC 658 at [24]-[25] (White J). (e) Fifth, an employer is entitled to protection against the use by the employee of knowledge obtained by him of his affairs and business methods: Dewes v Fitch at 181. (f) Finally, an employer's customer connection is an interest which can support a reasonable restraint of trade, especially so where the particular employee has, as against a particular client, become the human face of the business and the person who represents the business, or some aspect of the business, to the client: Cactus Imaging Pty Ltd v Peters [2006] NSWSC 717; (2006) 71 NSWLR 9 at [25] (Brereton J); Kearney v Crepaldi [2006] NSWSC 23 at [51]-[53] (McDougall J). In Arthur Murray Dance Studios of Cleveland Inc v Witter (1952) 105 NE (2d) 685, 705 (Ohio Common Pleas) Hoover J described this principle applying where: ... the employee, by contact with the customer, gets the customer so strongly attached to him that when the employee quits and joins a rival he automatically carries the customer with him in his pocket. Factual Context 5I should explain the factual context in which the dispute falls to be determined. The plaintiff commenced business in 1999 and is a software company specialising in ERP software (Enterprise Resource Planning) CRM software (Customer Relationship Management) and web software development. Its head office is in Sydney. It has a branch office in Melbourne and a small office in Brisbane. Since 1991 it has been growing steadily through organic growth and acquisition. It has developed its own comprehensive set of implementation and support methodologies to ensure that its interactions with clients are professional and successful. 6The plaintiff deploys and upgrades Sage ACCPAC ERP and Sage CRM software solutions. Sage ERP and CRM software packages are market leaders in the market in relation to those areas where they are applicable. The success of the plaintiff's business hinges not only on having qualified and experienced staff but also on having a good relationship with its clients. In most cases there is a very close working relationship between a consultant, such as the first defendant, and the client. The consultant goes to the client's workplace and may often actually work at the client's computer or in the client's office. It is the nature of the plaintiff's business that clients become attached to the consultant that services them. The plaintiff supports and encourages this relationship which, no doubt, underpins its desire to protect its business goodwill against the possibility that an employee will use the relationship for his or her own financial advantage. 7The particular nature of the business operations of the plaintiff explains the necessity in its case for restraints of the nature which are set out in clause 16 of the employment contract. The first defendant, like other consultants employed by the plaintiff, was exposed to a rigorous induction and training programme following which he was dedicated to particular customers. It is obvious that the customers rely on the individual employee/consultant for their support in relation to their software. I should add, although it is only of marginal relevance, that the plaintiff sponsored the first defendant on a Section 457 visa and supported his claim for permanent residence. 8In the course of the training and induction of the first defendant, he was exposed to a significant quantity of information that was confidential to the plaintiff. A detailed description of that information and the methodologies of the plaintiff are set out in the Professional Team Induction Booklet. It includes both internal procedures and external procedures. The external procedures are set out in documents which describe the way in which the consultant is to interact with the plaintiff's clients. Those procedures and methodologies have been developed by the plaintiff over the last ten years to ensure that the successful implementation of its ERP and CRM software. 9The plaintiff places a great deal of importance on the significance of those procedures and methodologies and on their confidentiality. It is not unreasonable for it to do so. It contends that the comprehensive training which it provides to its employees and the detailed induction process in the use of its methodologies and procedures constitute the reason for its commercial success. 10The significance and confidential nature of the information made available by the plaintiff to the first defendant in the course of his employment and induction is recognised and reinforced by Clause 15 of the employment contract. It is headed Confidentiality and Non-Disclosure and provides as follows: Confidentiality is the key element of good client relations in our industry; therefore, it is a requirement of your employment relationship with us that you agree: (a) To keep secret and not at any time (whether during or after the termination of your employment for whatever reason) use for your own or another's advantage, or reveal to any person, firm or company, any of the trade secrets, business methods, or information which you knew or ought reasonably to have known to be confidential concerning the business and affairs of the Company or any of its related or subsidiary companies, so far as they shall have come to your knowledge during your employment by the Company. The restrictions contained in this paragraph shall not apply to any disclosure or use authorised by the Directors or required by law or by the terms of your employment. (b) Not during or after the termination of your employment with the Company for any reason, remove any client list, client information, data base of any description whether on hard copy, computer disk or computer tape which is the property of the Company or any of its related or subsidiary companies. 11I accept the plaintiff's submission that its documentation, information and procedures are unique to it. They have been developed by the plaintiff. They are not available or published publicly and are considered confidential by the plaintiff. Setting Up in Competition 12The first defendant gave notice on or about 29 February 2012 and his employment ceased on 29 March 2012. It is apparent that on the very next day he was in the process of communicating and negotiating with representatives of one of the clients of the plaintiff, namely CFCL Australia Pty Ltd, for the continued provision of his services after the cessation of his employment. On 13 April a notification was received from Sage as to the termination of the plaintiff's contract with CFCL Australia. This was a surprising development. Indeed, it seemed to the plaintiff to be commercially inexplicable, particularly given the fact that CFCL Australia had previously expressed nothing but satisfaction and approval for the services that had been provided to it by the plaintiff. Not only CFCL but also another substantial client called ITW terminated its arrangements with the plaintiff within a very short time of the cessation of employment of the first defendant. 13One of the perplexing features of the circumstances in which CFCL Australia and ITW chose to leave the plaintiff was that the entity with which they arranged to have the same services provided to them was a company called Magni Pty Ltd. Unusually for the industry, Magni had no established presence as an operator in the industry. It conducts its business from an apartment on the Gold Coast in Queensland. It is a one-man band, in the sense that it is a corporate entity with one shareholder and director. 14The evidence was that experienced officers of the plaintiff had never known large clients such as ITW and CFCL Australia to use such a small unknown business operation for the provision of software support services. In some way, in which the evidence did not reveal precisely, the first defendant was the person through whom the services of Magni were provided to CFCL Australia and ITW. Challenges to Validity 15The first defendant's challenges to the validity of the restraint provisions in his employment contract can be reduced to a number of discrete issues. They are as follows: (a) Does the restraint against "directly or indirectly" trading in competition cover the first defendant's conduct in providing services through Magni Pty Ltd although he does not appear to be an officer or shareholder of that company? (b) Does the plaintiff have a legitimate protectable interest that justifies a restraint against trading in competition as distinct from non-solicitation of clients? (c) Does the Restraints of Trade Act 1976 apply? (d) Do the cartel provisions of the Competition and Consumer Act 2010 (Cth) apply? (e) Is the geographic extent of the restraints too wide? (f) Is the two year period of restraint after termination too long? (g) Is the restraint against non-solicitation too broad? Directly or Indirectly 16I have reached the view that the prohibition stipulating that the first defendant must not directly or indirectly trade in competition to the plaintiff covers the current activities of the first defendant as an employee or contractor of Magni Pty Ltd. The evidence does not reveal his precise status. But I cannot ignore the unusual features surrounding the first defendant's connection with Magni Pty Ltd. Without credible explanation, two major clients of the plaintiff followed the first defendant to Magni within days of the cessation of his employment with the plaintiff. He is now providing the identical service to them as he provided to them when employed by the plaintiff. By doing so he has acted in opposition to the commercial interests of the plaintiff. His actions have had the effect of taking some of the plaintiff's valuable clientele, reducing its revenue and presumably, also its profit. 17In relation to those two clients the first defendant has acted as a rival of his former employer. In an effective practical sense he has not only competed for their business but he has stolen it. I have no doubt that the particular conduct of the first defendant in this case contravenes the prohibition against trading in competition with his former employer. In its overall context and having regard to its evident purpose and object, the natural construction of the words "trade in competition" covers the first defendant's provision of services through Magni Pty Ltd. In its broader sense, to "trade" means no more than to engage in a particular line of business: Cooney v Council of the Municipality of Ku-ring-gai [1963] HCA 47; (1963) 114 CLR 582 at 601-602. And the adverb "indirectly" has important work to do. 18The outcome might or might not be different if the first defendant were simply working as one of many employees for another large organisation. I need not go there. On the unique facts of this case however, his conduct is clearly caught. He is directly or indirectly engaging in a line of business in competition with the plaintiff. The prohibition against directly or indirectly trading in competition could not have been intended to allow a former employee to circumvent its effective operation by the ruse of providing services through a one-man band, even if it is an incorporated entity of which the first defendant is not an officer nor the legal owner of shares. The further hearing that will follow my decision on these separate issues will investigate the precise economic interest that the first defendant holds in Magni Pty Ltd. Legitimate Interest 19There was no disagreement that the plaintiff had a legitimate interest that justified a restraint against solicitation of its client. The first defendant contended, however, that there was no legitimate interest that justified the restraint against competition. I do not agree. The employment contract acknowledged the existence of business methods and information which were confidential to the affairs of the plaintiff. The first defendant agreed to keep those business methods and that information secret. He promised not to use them for his own or any other person's advantage during and after the termination of his employment. There was abundant evidence that supported, at least in broad terms, the existence of business methods and information that the plaintiff regarded as unique and which it was justified in seeking to protect. 20It is well accepted that the possibility that a former employee might be in a position to utilise his former employer's confidential information or business methods to the latter's disadvantage, is a proper basis for imposing a post-employment restraint on trade: Lindner v Murdock's Garage [1950] HCA 48; (1950) 83 CLR 628 at 650 (Fullagar J); Cactus Imaging at [13]. The employer cannot be expected to rely solely on its right to restrain the improper use of confidential information. That can be a hit and miss affair and proof of its elements may sometimes be difficult: Littlewoods Organisation Ltd v Harris [1977] 1 WLR 1472 at 1479 (Lord Denning MR). The most satisfactory, and the commonly used and accepted, method of protecting the employer's interest is to impose a restraint on trading in competition. I reject the submission that there is no legitimate interest that supports the restraint on trade as distinct from the restraint on solicitation of clients. Restraints of Trade Act 21The issue as to whether the Restraints of Trade Act applies turns on the determination of the proper law of the employment contract. The proper law is the system of law with which the contract has the closest and most real connection: Bonython v Commonwealth [1951] AC 201 at 209 (Lord Simonds); Oceanic Sun Line Special Shipping Co Inc v Fay [1988] HCA 32; (1988) 165 CLR 197 at 217 (Wilson and Toohey JJ). The plaintiff contended for New South Wales and the first defendant for Victoria. I have reached the view that the law of New South Wales is the proper law and that the Restraints of Trade Act applies. 22The head office of the plaintiff is in New South Wales. That is where the employment of the first defendant was administered and controlled, and from where he was paid. The connection with Victoria is in truth ephemeral. It is true that the contract provided that the first defendant would be located in Melbourne, at least initially. It also specified that travel between Sydney and Melbourne would be required. And the clients that he serviced were, and were always expected to be, in both states and possibly elsewhere. It cannot be said accurately that the contract was performed in Victoria. It was performed in Victoria and New South Wales, and intended to be so. In fact, the nature of the work rendered the place of performance fortuitous and somewhat irrelevant. The place of performance on site depended on where the client was located. Other advice and consultative work were undertaken and effected by electronic communications or by telephone. 23The fact that the formation of the contract may possibly have taken place in Queensland from where the first defendant sent his acceptance of the plaintiff's offer by return post is a diversion but does not effect the conclusion. The place where a contract is made is sometimes relevant but not in this case. The system of law with which the contract has the closest and most real connection is New South Wales. Competition and Consumer Act 24An amusing component of the first defendant's armoury of contentions and arguments was the proposition that the restraint on trade contained in the employment contract contravened the cartel provisions of the Competition and Consumer Act. It was said that the restraint on trade had the purpose of preventing, restricting or limiting the supply of services by the first defendant. 25I need not decide whether that was its purpose or whether it was merely its effect. The answer lies in the exception set out in Section 51(2)(b) of the Act. It provides: (2) In determining whether a contravention of a provision of this Part... has been committed, regard shall not be had: (a) ... (b) to any provision of a contract of service or of a contract for the provision of services, being a provision under which a person... agrees to accept restrictions as to the work, whether as an employee or otherwise, in which he or she may engage during, or after the termination of, the contract. 26The restraint on trading in competition set out in Clause 16(b) of the employment contract is properly characterised as a restriction "as to the work, whether as an employee or otherwise, in which he or she may engage during or after the termination of the contract". The evident statutory purpose of Section 51(2)(b) is to save restraints on trade in employment contracts from the reach and sweep of the cartel provisions of the Act. I do not think that any different characterisation or conclusion is reasonable or likely or appropriate. Geographic, Temporal and other Limitations 27The plaintiff accepts that in the exercise of my power pursuant to Section 4 of the Restraints of Trade Act it would be appropriate to limit the scope of operation of the restraint against competition to New South Wales, Victoria and Queensland. I will do so. 28It is also necessary to confine the restraint against solicitation to ensure that it is reasonable and no more than is necessary to protect the legitimate interests of the plaintiff. As currently drafted the words "any person or entity who has dealt with Provida during the 12 months prior to termination" could operate far too widely. The restraint should be restricted so as to apply only to clients of the plaintiff to whom the first defendant has, himself, provided services. 29As to the post-employment temporal limitation applicable to both restraints, I accept that the nature of the business, the method of operation, the close personal contact between consultants and clients and the confidentiality of the plaintiff's information and methodologies all justify an appropriate period of restraint. However I think the two years is unreasonable and beyond the period that is necessary to protect the legitimate interests of the plaintiff. Against the possibility that I would make such a finding, counsel for the plaintiff submitted that the appropriate period should be twelve (12) months. Counsel for the first defendant suggested six (6) months. 30One of the primary factors in this case in determining the reasonableness of the length of the restraint is the time that will be necessary to ensure the severance of the connection between the first defendant and the clients he serviced while in the employ of the plaintiff. Each case will depend on its own facts. The exercise of my discretion in this case reflects my view of what is reasonable to ensure the severance of that connection. There is no tariff and no standard formula. In the result, I have reached the view that the two-year post-employment period of restraint in clause 16 of the employment contract, insofar as it relates to non-solicitation and trade in competition, should be limited to ten (10) months. Conclusion 31These reasons represent my decision on the separate issues raised by paragraphs 1, 2, 3 and 4 of the amended defence. The parties joined in asking me to determine those issues in advance of all other issues and claims in the proceedings. The first defendant has had some success in limiting the breath of clause 16 of the employment contract. The parties should deliver to my associate agreed short minutes that reflect these reasons. The draft orders should include an appropriate order pursuant to 32Section 4 of the Restraints of Trade Act. The balance of the proceedings should be removed from the expedition list and should be listed before the Registrar in Equity at a convenient time. 33The first defendant should pay 60 per cent of the plaintiff's costs of this separate hearing. Although he has succeeded in reducing the period of his restraint, the first defendant's primary submission was that he was not bound at all by the restraints set out in Clause 16. In addition, most of the time at the hearing was spent on issues on which he has failed. On the other hand, the plaintiff sought to uphold restraints which I have found were too wide, too long and too broad. In the form set out in Clause 16, they were not reasonably necessary to support the legitimate interests of the plaintiff. oOo DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 05 September 2012