Restrictive Covenants in Employment Contract

Q.
I am a cook. Recently, I am approached by a prospective employer for a job offer. My employer has included a restrictive covenant in my service contract which prohibits me from joining any future employer who is in the vicinity of the new restaurant he is setting up. Is this clause fair and legal in employment contract?

A.
This is a typical question that comes out from Law Examination. It involves the employment law and contract law.

On the broader sense, any restrictive clause would be viewed as unfair, and contradicting the doctrine of freedom of movement, speech, assembly and association. This is enshrined in the Federal Constitution Articles 9 and 10. On a more stringent interpretation, the restrictive nature of the clause seems to enslave the employee into solely working for the employer, and this is contradicting to Article 6 of the Federal Constitution where Slavery and Forced Labour is prohibited.

Furthermore, Article 8 on Equality, clause (2) provides that

"except as expressly authorized by this Constitution, there shall be no discrimination against citizens on the ground only of religion, race, descent, place of birth or gender in any law or in the appointment to any office or employment under a public authority or in the administration of any law relating to the acquisition, holding or disposition of property or the establishing or carrying on of any trade, business, profession, vocation or employment." (Bold - highlights of my own)

Here, any trade, business, profession, vocation or employment are encompassing all activities of interaction in trades and businesses. Hence, any restriction to such activity would be contradicting the principle of Equality as enshrined in Article 8 of the Federal Constitution.

However, if the restrictive clause is to protect certain investment, as to restrict insider trading or criminal act of breach of trust, then, it is considered acceptable. For instance, a huge capital investment from a prospective employer who is genuinely legitimate in opening a restaurant in a new housing estate. And, his business venture is dependent on the special signature dish of native French Cuisine which you are employed for. He does not mind paying you a fat salary for coming to his restaurant as the lead chef, however he has to protect his interest in the business venture that you cannot, inter alia:

1. Join another employer engaging in the same trade;
2. Start up another similar trade nearby, within 5 km radius; and
3. Engage in any activity of imparting or pass on the knowledge of the trade to a third party without the permission from the employer.

Such restrictive clause may be viewed as protecting the rights of the employer to his venture. For, he is embarking into a risky business and thus, a certain reasonable protection be fair to his venture. The same is for copyrights and patent protection.

A good write up of this issue has been published by Jonathan Coley and Edward Goodwyn of Out-Law.com entitled "Restrictive covenants in employment contracts" and is based on UK law. It was last updated in October 2013 here.

As a summary, restrictive covenants are limited but legal and enforceable in employment contracts. There is strict guidance to whether such restrictive covenant is acceptable in a particular industry and base on the local laws of that country.

Some examples of restrictive covenants commonly used are:

Types of restrictive covenants

The standard types of restrictions which can be used by employers are:

1. non-competition covenants - restrictions on the former employee working in similar employment for a competitor;
2. non-solicitation covenants – which prevent poaching of clients/customers/suppliers of the former employer;
3. non-dealing covenants – which prevent a former employee from dealing with former clients/customers/suppliers, regardless of which party approached the other;
4. non-poaching covenants – which prevent an employee poaching former colleagues

From the write up of Coley and Goodwyn above, I verbatim a short portion below:

"The extent of clauses, therefore, must be relative to the employee's position within the business. As more senior employees will be in contact with more sensitive information, restrictions placed upon them may be justified as being more onerous. Overall, a one-size fits-all policy on restrictive covenant clauses risks the clause becoming unenforceable.

Restrictive covenants may also require periodic review in order to maintain their enforceability as the reasonableness of the covenant is judged at the time it was entered into.

The court may have regard to what is standard practice in the employer's industry with regard to such covenants and the above factors."

On the other hand, if it is viewed from the law of Contract Act, 1950 (hereafter CA 1050), it is entirely prohibited!

Section 28 of CA 1950 mentions that:

"Agreement in restraint of trade void"

"Every agreement by which anyone is restrained from exercising a lawful profession, trade, or business of any kind, is to that extent void."

Therefore, in such situation, the restriction covenant is void under CA 1950.

From a write up by Sivabalah Nadarajah of Shearn Delamore & Co., in "A regional guide to 'restrictive covenant', Asia", restrictive covenant in employment contract is illegal in Malaysia because of strict adherence to S.28 of the 'restraint of trade void' provision. Nevertheless, there are three (3) exceptions according to him:

1. There is an agreement not to carry on business of which goodwill is sold; or
2. There is an agreement between partners prior to dissolution;
3. There is an agreement during the continuance of a partnership.

Another issue of restrictive covenant is the notion that there is no competition - thus the Non-Competition clause (or non-compete clause). This is against the nature of Anti-Trust or Anti-Competition of the US. But, in Malaysia, the Malaysia Competition Act, 2010 (hereafter MCA 2010) is more on competition among enterprises, less on competition as restrictive of trade.

Furthermore, the MCA 2010 in its subsection S. 10 (3) specifies that:

"This section does not prohibit an enterprise in a dominant position from taking any step which has reasonable commercial justification or represents a reasonable commercial response to the market entry or market conduct of a competitor."

Therefore, what is interpreted as "commercial justification" is very much depending on the argument base on the industry or the nature of trade. In my opinion, the MCA 2010 does not provide clear guidance on anti-competition law on the above restriction covenant.

Thus, relying on the Employment Act and Contract Act, the answers to the following questions are extracted from Sivabalan Nadarajah's article:

Q.

Can an employer require a post-termination non-competition covenant from an employee? 

A.

No 

Q.

Are they capable of being valid? 

A.

No 

Q.

What does it take to show they are valid (legitimate interest, drafting pitfalls to avoid)? 

A.

The effect of having a non-competition clause in an employment contract is that the employee will be prohibited from joining any organization that is deemed to be a competitor to its employer. When the employee is prohibited from joining any organization after they cease employment with their former employer, this will amount to restraint of trade which is expressly prohibited under Section 28 of the CA 1950. 

No matter how narrow or wide the covenant was drafted, the employer would not be able to impose a non-competition covenant against its employee. However, if the employer can prove that the non-competition clause falls within the exception to Section 28 of the CA 1950, it may be valid and enforceable.

A case study:

In the case of Svenson Hair Centre Sdn Bhd v Irene Chin Zee Ling, an injunction was sought by the employer against the ex-employee to restrain the ex-employee from contacting or corresponding with all or any of the employer’s present customers.

The injunction was allowed. 

The Court held that the injunction sought was merely to stop her from calling, approaching or contacting the employer’s customers that appear on the customer’s list, as opposed to stopping the employer from working with the competing business. 

We take the view that the restrain sought by the employer in the above case amounts to restraint of trade under Section 28 of the CA 1950. By prohibiting contact with customers/clients, the ex-employee is restrained from freely conducting their own trade in any manner they wish. Although it is arguable that the list of customer is the employer’s confidential information but that does not mean that the customer can only conduct business with the employer.

In the circumstances, the injunction should not be allowed as it contravenes the express provision of the law. It is unlikely that the above decision will be followed by other Malaysian courts.

Ref:
- The Federal Constitution of Malaysia. Available at,
http://www.agc.gov.my/images/Personalisation/Buss/pdf/Federal%20Consti%20%28BI%20text%29.pdf
- Contract Act, 1950. Available at,
http://www.agc.gov.my/Akta/Vol.%203/Act%20136.pdf
- Jonathan Coley and Edward Goodwyn. 2013. Restrictive covenants in employment contracts. Out-Law.com. Available at,
http://www.out-law.com/page-7086
- Sivabalan Nadarajah. in A Regional Guide to 'Restrictive Covenant' Asia. Available at,
http://www.simpsongrierson.com/assets/pdfs/eBook%20App_Asia_Regional%20Guide%20to%20Restrictive%20Covenants.pdf
- Malaysia Competition Act, 2010. Available at,
http://mycc.gov.my/wp-content/uploads/2014/05/CA2010.pdf