Not all non-compete clauses are equal: The importance of careful drafting

The recent NSW Court of Appeal case DXC Eclipse v Wildsmith [2023] NSWCA 98 emphasises the importance of drafting non-compete restraints in contracts between companies to avoid them being unenforceable due to unreasonableness. Such oversights leave purchasers of businesses in a position where their legal rights under the contract are less than what they had anticipated and opens the door to costly and uncertain litigation.

Outline of case

DXC Eclipse acquired a business called Sable37 in April 2018 from Mr Wildsmith, who was its managing director. Under the sale agreement, Mr Wildsmith was subject to a non-competition clause. This contract:

• stated that Mr Wildsmith could not carry on a competing business during a maximum restraint period of 7 years, or if not, then a cascading series of time periods from one to seven years;
• contained an acknowledgement that this restraint was reasonable and necessary to protect the purchase value; and
• required Mr Wildsmith to serve as the DXC Eclipse’s ‘ANZ Director – Microsoft’ for at least one year after the acquisition.

His employment contract itself contained a 6-month non-compete clause. Mr Wildsmith served in this position for three years, resigning in June 2021. In December 2021, he incorporated a new company called Will Thirty Three. DXC Eclipse then sought an injunction to enforce the non-competition restraint clause.

The judge at first instance rejected DXC Eclipse’s claim on the basis that the seller had not breached the restraint clause. DXC Eclipse then appealed. The Court of Appeal dismissed this appeal because:

• Mr Wildsmith did not breach the restraint since the two companies offered different software services; and
• regardless, the 7-year restraint period was unreasonable.

The court rejected the argument that the software products which Will Thirty Three used were ‘future, successor or derivative’ products to those used by Sable37, as the sale contract described. Bell CJ therefore rejected the argument that Mr Wildsmith’s new company might present a real commercial threat to the purchaser.

In the Court of Appeal, Bell CJ emphasised that assessing the reasonableness of non-competition restraints requires asking what period is necessary to protect the purchaser from being deprived of the acquired business’s goodwill. Although reasonableness is assessed at time when contract is entered, the discretion whether to enforce a restrain may be informed by considerations at the time of enforcement. This reasonableness is dependent on the actual level of competition between the buyer’s and seller’s businesses. Where minimal levels of competition exist between the businesses of the seller and buyer, longer or more extensive restraint periods are less likely to be reasonable.

The court ultimately found that DXC Eclipse failed to demonstrate that the 7-year restraint period was necessary to prevent it being deprived of the acquired company’s goodwill. The purchaser had enjoyed over four years free from competition from Mr Wildsmith or any company associated with him. Also, it had benefitted from Mr Wildsmith’s talents as an employee for a longer period than the 12 months required under the agreement. He had also complied with his employment contract’s restraint. Bell CJ found that the 12-month post-sale employment requirement to some extent indicated how long a restraint DXC Eclipse considered necessary to protect the goodwill it acquired.

Regarding the sale contract’s acknowledgement of the reasonableness of the restraint, Bell CJ was receptive to the argument that its importance was lessened by the agreement’s descending cascade of restraint periods coupled with provisions stating that clauses which were struck out would be severed.

Takeaways

In summary, the court refused to order injunctive relief since no breach was established and, in any case, the restraint was unreasonable. The case demonstrates:

• That to establish breach, it is necessary that the seller’s new business might pose a real commercial threat to, or would compete seriously, with the purchaser’s business.
• The importance of carefully drafting non-competition restraints in business sale agreements to avoid them being held unreasonable and unenforceable. Restraint periods must be necessary to shield the purchaser from being deprived of the acquired company’s goodwill.
• That in assessing the reasonableness of restraints, one must consider all aspects of the transaction as an integrated whole. That is, there is no ‘bright line’, but rather the restraint must be proportionate to protecting the goodwill being acquired.
• Particularly, if key personnel are engaged by the purchaser, a court may take into account the employment period in deciding whether the restraint is reasonable.