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How do non-compete clauses work for independent contractors?

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This guide outlines what non-compete clauses are, and how to use them to protect your business when employing contractors.

When an independent contractor or an employee leaves a company, and subsequently poaches clients and/or takes advantage of confidential business information it can cause serious damage to that company. To prevent this, businesses place restraint or non-compete clauses in their contracts and agreements with employees and independent contractors.

Understanding non-compete clauses

Restraint and non-compete clauses aren’t always enforceable, so to avoid complications, employers should have a clear understanding of what a fair and legal restraint or non-compete clause is and whether it can be applied to an independent contractor in the same way as an employee.

What is a restraint or non-compete clause?

A restraint or non-compete clause within a contract protects a business’ interests by preventing a former independent contractor or employee from taking advantage of the confidential information which was acquired on the job and/or engaging in specific competitive activities with other businesses which would directly and negatively impact the business. This means that a former independent contractor or employee may be prevented from working for a competitor for a particular amount of time, disclosing confidential or commercially sensitive information or soliciting work from former clients.

However, employers should be aware that a restraint or non-compete clause won’t always work as intended, as courts will only uphold it if it is considered ‘reasonable.’

What makes a restraint or non-compete clause reasonable or unreasonable?

When employers implement restraint or non-compete clauses in their contracts, they need to be careful not to deny former independent contractors and employees the ability to earn an income or to maintain their own business interests, as this may be ‘unreasonable. If the court considers this clause ‘unreasonable,’ it will not be enforceable.

In the Australian courts, a restraint or non-compete clause is typically between three and 12 months’ in duration, is restricted to a specific geographical area and is reliant on a special need to restrain conduct. In order to determine whether a restraint or non-compete clause is reasonable, the court will consider these factors and make a decision which will determine whether the clause is enforceable or not.

However, employers in NSW should be aware that as a result of the Restraints of Trade Act 1976 (NSW), a NSW Court can solely decide what would be reasonable, and thus can amend the restraint/non-compete clause accordingly.

Therefore, employers should note that if they make this clause too strong, the court is likely to consider it unreasonable, and therefore, it may be changed or not enforceable by law.

What is the difference between how restraint or non-compete clauses are applied to employees and contractors?

The presence of a strong restraint or non-compete clause in an independent contractor’s contract, can inadvertently mean they will be treated as an employee under the law. This can lead to additional tax, superannuation and workers compensation responsibilities.

The constant dispute and ambiguity over determining an employee versus a contractor is complex. A key factor to determine this includes the level of control a business exerts over that person.

For example, if the degree of control is low, it is likely they will be considered a contractor, however if control is high, it is likely they will be considered an employee. This means that the restraint or non-compete clause itself can determine that a contractor is legally considered an employee if the degree of control from the business is high.

This ensures that contractors are not being exploited in relation to being paid the additional benefits of an employee, including superannuation, workers compensation, etc. So what’s the difference between an employee and contractor?

Employee:

–          Is remunerated on a fixed basis through payment of salary or wages

–          Is paid leave entitlements

–          Has different tax and superannuation implications

–          Specifically works in your business and is a part of it

Contractors:

–          Determine their own scope of employment

–          Have powers of delegation

–          Are paid on a performance and/or project basis

–          Have their own Australian Business Number (ABN)

–          Can freely refuse and accept work

–          Run their own business

To help decipher whether an individual is an employee or a contractor, the Australian Taxation Office has formed an Employee/contractor decision tool where employers can put in specific information of the person in question to get an idea of whether they are an employee or a contractor.

Whilst for now this tool is useful, a High Court decision was handed down in February 2022 which has implications that may change how employees and contractors are treated under the law. Therefore, employees should stay updated on this topic.

How to get the balance right on restraint or non-compete clauses

When incorporating restraint clauses in an independent contractor’s agreement, it is important to find the balance between reasonably protecting the interests of the business whilst ensuring that the contractor is not being controlled excessively, especially to a point which prevents the contractor from conducting their own business.

Here are a few conditions which may make your restraint or non-compete clause reasonable:

–          Protection of the business’ confidential information

–          Protection of the business’ clients and staff from solicitation

–          Protecting copyright information

–          Protecting your clients from being poached

Conclusion

Ensuring the balance between protecting the business’ interests vs. maintaining control over the independent contractor is important because if the clause is too strong, the contractor may be considered an employee, meaning that the employer will need to pay superannuation, worker’s compensation and any other compulsory payments for employees. Talk to your lawyer to ensure you’re striking the right balance and not exposing the business to any undue risk.

About Rolf Howard

rolfh@thebusinesswomanmedia.com'

Rolf Howard is Managing Partner of Owen Hodge Lawyers. He has been in the legal practice since 1986 and a partner of Owen Hodge Lawyers since 1992. Rolf focuses on assisting clients to proactively manage legal responsibilities and opportunities to achieve competitive advantage. Rolf concentrates on business planning and formation, directors’ duties, corporate governance, fund raising and business succession. His major interest is to assist business owners and their financial advisers plan and implement strategies to build and exit from successful businesses.

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