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Can independent contractors be restrained from soliciting and competing with their principal?

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28 Sep 2018

When an employee or independent contractor leaves a business, they have the potential to significantly damage the business by misusing confidential information and client relationships. To prevent this, many businesses utilise restraints and confidentiality clauses within their employment contracts and independent contractor agreements.

A restraint of trade clause attempts to prevent an employee and/or independent contractor from engaging in competitive activities which may adversely affect the business. However, given that independent contractors are engaged to provide services on an independent basis, the ability to restrain them from working for competitors is problematic as it places fetters on the very independence that marks a contractor relationship.

As such, many businesses are unsure how to properly protect their business interests from competition by independent contractors engaged by the business. In this article, we look at whether companies can safeguard themselves from independent contractors misusing their confidential information and discuss a recent decision handed down by the NSW Court of Appeal on this key issue.

Restraint of Trade Principles

The general law considers restraint of trade clauses unenforceable unless the restraints are reasonable and necessary to protect the legitimate interest of the business. The first hurdle for a business which is trying to enforce a restraint is the legitimacy of the interest that the business seeks to protect. A business is not entitled to merely stop others from competing. In order to determine whether a restraint is reasonable, the court will consider the duration of the restraint, and its geographical operation. Restraints that do not meet the test of “reasonableness” may be struck out by the Courts. However, it is worthy to note that in NSW as a result of the Restraints of Trade Act 1976 (NSW), an NSW Court does not have to be bound by the contractual clause, but can decide for itself what would be reasonable and amend the clause accordingly. 

As most people understand, restraints are designed to protect the legitimate interest and goodwill of the business. However, it can become more complex when dealing with restraints contained within independent contractor agreements as the goodwill and/or interests of the business can be hard to distinguish from the contractor’s own business. This concept was considered in a recent Court of Appeal decision.

Recent case law

In Isaac v Dargan Financial Pty Ltd [2018] NSWCA 163 the Court of Appeal considered whether a business could restrain an independent contractor from disclosing confidential information and soliciting and interfering with the principal’s client relationships.

Mr Isaac was engaged by Dargan Financial Pty Ltd (“Dargan”) trading as Home Loan Expert (“HLE”) as a sub-originator pursuant to a sub-originating agreement (“the Agreement”) which prohibited him from using HLE’s confidential information including its client lists. The Agreement also contained an 18-month post-termination restraint clause which prohibited Mr Isaac from soliciting, canvassing, approaching or accepting any approach from any person who was at any time in the 24 months prior to the termination of the Agreement a client of HLE.

The Agreement was terminated by the parties by mutual consent. Shortly after the termination of the Agreement, Mr Isaac commenced work for RAMS Financial Group and acted for nine persons who had existing loans with Dargan. As a result, Dargan commenced proceedings against Mr Isaac for breaching the contractual confidentiality provisions and breaching an equitable obligation of confidence by using and retaining a list of Dargan’s clients, and a breach of the non-solicitation restraint and non-interference restraint by approaching and accepting approaches from Dargan’s clients.

Mr Isaac admitted to retaining and using the list of Dargan’s clients, soliciting clients of Dargan and accepting approaches from clients of Dargan while employed by RAMS. However, Mr Isaac argued that certain client list had entered the public domain by its disclosure in open court and that the restraints were unreasonable and thus unenforceable.

At first instance, the primary judge upheld Dargan’s claim. His Honour made orders permanently restraining Mr Isaac from disclosing or using Dargan’s client list, and restrained Mr Isaac in relation to his restraints. His Honour also ordered that Mr Isaac pay Dargan approximately $66,030 in damages and Dargan’s costs of the proceedings.

Mr Isaac appealed this decision.  The Court of Appeal confirmed the principles in relation to restraints and confirmed that the principles apply to the relationship between contractor and principal.

However, the Court of Appeal found that Mr Isaac had not breached the non-interference restraint mainly as a result of insufficient evidence. It also found that there was no utility in making orders regarding the maintenance of confidentiality of Dargan’s client lists as Dargan had allowed the list to be tendered in open court and had as a result become part of the public domain. However, the remaining issue as to whether the non-solicitation restraint was reasonable and enforceable was upheld.

In particular, the Court of Appeal considered the question of whether there was a difference between protecting Dargan’s legitimate interests and Mr Isaac’s business as an independent contractor. It was held that Dargan had a legitimate commercial interest in protecting its customer connections and confidential information in relation to its clients, notwithstanding the substantial involvement of Mr Isaac as a contractor with the clients with whom he dealt.  Ultimately, it was held that the client relationships remained with Dargan and Dargan held a level of control over the clients. The Court of Appeal also considered whether the restraint period was reasonable. In this regard, it was held that the 18-month restraint was found to be reasonable considering the specific industry in question.

Lessons for Businesses

It is crucial for businesses to ensure they are appropriately protecting their business interests and understand how to go about doing this. Specifically, when engaging independent contractors, ensure your business takes the following steps to properly protect your business’ goodwill and/or interests:

  • Ensure there is an appropriate up to date independent contractor agreement in place;
  • Ensure the independent contractor agreement contains well drafted and reasonable restraint of trade and confidentiality clauses taking into account the nature of the relationship;
  • Ensure that the restraint of trade clauses sufficiently protect the company’s legitimate interests and are tailored to suit the individual circumstances;
  • Ensure that if the independent contractor is engaged within a client-facing role, the business retains a level of control of the client relationships including any clients which the independent contractor brings to the business;
  • It is also important to note that the above decision highlighted the fact the contractor agreement did not define the term ‘confidential information’ which meant that Dargan had not specified what information it considered to be confidential.  In this regard, it is vital that any independent contractor agreement (or any employment agreement for that matter) contains proper definitions that reflect your business environment; and
  • Ensure that confidential information is kept confidential and not inadvertently disclosed.

If you wish to discuss any aspect of this article or require specialist advice or assistance in relation to an employment law matter, please do not hesitate to contact us.

This alert is not intended to constitute, and should not be treated as, legal advice.