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Beware of Restraints of Trade

Newsletter 01 July 2013

The last decade has seen an increase in the number of cases involving restraints of trade in health practices brought before the NSW Courts.  There has also been an increase in the number of unlitigated cases.  One of the major factors for the increase has been the growth in corporate health care whereby small health practices are being bought out in return for the health practitioner entering into a practitioner contract that includes a restraint of trade.  After working for the corporate health practice for a set period, a number of health practitioners have tried to move to other health practices but have found themselves subject to agreed restrictions upon their ability to practise.

It has become clear that many health practitioners are entering into restraints of trade that will impact upon their practice many years into the future but they do not really understand what they have agreed to restrain from doing.  Other health practitioners are requesting restraints of trade be incorporated into their employees’ contracts but sometimes they do not really understand what they are able to protect. Therefore it is important for all health practitioners to carefully consider the implications of entering into a restraint of trade before signing on the dotted line.

What is a ‘restraint of trade’?

A restraint of trade (also referred to as a restrictive covenant) is a clause that is inserted into written practice agreements such as sale of business agreements, health practitioner service agreements and employment contracts; that restrict an individual from practising in a particular geographical area, for a specified period both during, and after, working for a specified health practice.  Restraint clauses normally also include provisions to prevent a health practitioner soliciting patients or taking confidential information away from the specified health practice.

A ‘cascading’ restraint is where there are a number of restraints within a written practice agreement that are said to apply for varying time periods in varying geographical locations.  For instance, a health practitioner may be restrained for: 12 months over a 3km radius, or 6 months over a 5km radius, or 3 months over a 10km radius.

It is important to note that the Courts have distinguished between a restraint following the sale of a business and a restraint following employment. A stricter approach has been taken by the Courts to restraints on employees due to the perceived lack of bargaining power held by employees in contrast to the bargaining power held by the seller of a business, and the competing interest of the employee to earn a living against the need of an employer to protect its legitimate business interests.

Is a ‘restraint’ legal?

The general position is that: ‘all contracts in restraint of trade are void unless it is proved that the restraint is reasonable’ (Young JA at [85] in Sidameneo (No 456) Pty Ltd v Alexander [2011] NSWCA 418).

It is for the party wishing to enforce the restraint (i.e. the health practice) to prove that the restraint is reasonable and therefore valid.  If it can do so, it is then for the other party (i.e. the health practitioner) to prove that enforcing the restraint would not be in the public interest.

What is a ‘reasonable’ restraint?

The question as to whether or not a restraint is reasonable is judged at the time at which the restraint is agreed (Cactus Imaging Pty Ltd v Peters [2006] NSWSC 717) and determined by looking at what the parties initially negotiated.

For a restraint to be reasonable, it needs to protect a ‘legitimate interest’ of the party wishing to enforce the restraint.  This is an important factor and is why there is a different approach taken to restraints following the sale of a business in contrast to restraints following employment.  The legitimate interest of the purchaser of a business is essentially the goodwill of the business.  The legitimate interest of an employer is limited to trade secrets (i.e. confidential information and customer connection). An employer cannot completely prevent a former employee from competing with the employer. The validity of a restraint is also established by the Restraints of Trade Act 1976 (NSW).  Section 4 provides that: ‘A restraint of trade is valid to the extent to which it is not against public policy’.

What is ‘public policy’?

This is determined as a matter of fact in each individual case. In Idameneo (No 123) Pty Limited v Dr Teresa Angel-Honnibal (2002) NSWSC 1214 the NSW Supreme Court decided that Idameneo had no legitimate interest to protect arising from the practitioner service agreement which simply required a health practitioner to pay a medical centre for the provision of services.  The restraint clause was void as contrary to public policy.

The Courts will however uphold a restraint in a sale of business agreement as it is not contrary to public policy.  Instead, the restraint is likely to be considered reasonable on the basis that the legitimate interest is to protect the goodwill acquired by the purchaser.

What happens if there is a breach of a valid restraint?

Determining if there has been a breach of a restraint is a matter of fact.  The Courts will look at the initial written agreements, negotiations around those initial agreements and the basis for termination of those agreements.  The party wishing to enforce the restraint has two options:

  1. An Injunction

An injunction is known as interlocutory relief.  That is, the party seeking to impose the restraint is attempting to immediately (i.e. the next day) restrain the other party from working or carrying out the prohibited activity at another place.  There always has to be a final hearing but the interlocutory hearing will evaluate the strength of the case and is indicative of the final outcome.

Even if a restraint has been breached an injunction does not automatically follow. In the case of Idameneo (No 123) v Butterworth [2013] 2013 NSWSC 357 Idameneo’s application for an interlocutory injunction against Dr Butterworth was unsuccessful on the basis that the practitioner service agreement provided a remedy for breach of contract being the payment of liquidated damages.  The fact the final hearing of the matter was listed soon after in June 2013 was also taken into account.

  1. Monetary Compensation

The party seeking to enforce the restraint may also seek monetary compensation and/or liquidated damages.  This is more likely to happen if by the time the matter is before the Courts the restraint period has passed.  The Courts will consider if the party seeking to enforce the restraint has suffered damage and, if so, the amount of that damage.  It can be difficult to prove.

It is possible that even if there is a valid restraint which has been breached, that there is no monetary remedy for the party trying to enforce the restraint.  A clear illustration of this is the case of Sidameneo decided by the NSW Court of Appeal on 21 December 2011.

Court proceedings were initiated on 5 February 2009 by Sidameneo to restrain a number of doctors from working at a rival medical practice and from inducing staff to leave Sidameneo’s medical practice.  The doctors had sold their medical practices in January 2002 for significant sums of money to Symbion (the former name of Sidameneo).  They then entered into practitioner service agreements (which contained cascading restraints) to work at a new medical practice.  After a change in ownership of the medical practice, the doctors gave notice (on 16 January 2009) that they were terminating their agreements and that they would cease to work at the medical practice from 30 January 2009.  They commenced working at a rival medical practice on 2 February 2009.  By the time the matter was before the Court, the time limits in the restraints had expired so the issue was whether Sidameneo was entitled to damages.

The restraint in dispute restricted the doctors for a period of 1 year from practising within a 3km radius from the Sidameneo medical practice following termination of their agreements. The Court concluded that the ‘covenant is about as basic as one could impose.  Thus the covenant is valid.’[102]  However, when it came to determining the issue of damage the Court was not satisfied that the breach by any of the doctors involved caused Sidameneo any provable loss.  The doctors won.  Whilst it is important to keep in mind the comments of the Court that: ‘[t]he decided cases are very much fact specific and that it is very dangerous to attempt to deduce a general rule from them’ [44], this case does illustrate that it is easier for the party seeking to enforce a restraint to attempt to obtain an injunction during the restraint period rather than monetary compensation following the expiry of a restraint.

Conclusion

Health practitioners need to understand that restraints entered into between a seller and purchaser of a business, such as a health practice, will be taken seriously and enforced by the Courts in New South Wales.


Karen Keogh, Partner
Sydney

Newsletter 01 July 2013
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