In a previous article, we spoke about restraint clauses. But we didn’t cover restraint clauses in relation to company directors, who want to start their own companies. Like most employees, company directors have access to the inner mechanisms of a business. Unlike employees, though, company directors are at the helm. The information they can access is often significantly more sensitive than that which is available to others within the organisation. Understandably, companies want reliable assurances that their sensitive information won’t be put to use against them. However, directors frequently start their own companies. After all, directors are well-positioned to apply their specialist knowledge to the management of a new company. They routinely take career opportunities that are presented to them, and have every right to do so. But what about the information they possess? There are two primary mechanisms that companies employ to gain the assurance that their former directors won’t work against company interests. The first is directors’ duties, and the second is restraints of trade. So let’s have a look at how they work.
Fiduciary and directors’ duties: company directors are bound by more than just their contracts
Directors’ duties are a derivative of fiduciary duties. Directors’ duties are enshrined in the Corporations Act, and they’re the main framework for directorial conduct. When a director becomes a director, he or she is automatically bound by the directors’ duties, as set out in the Act, and fiduciary duties. The duties are designed to ensure that company directors do not act contrary to the interests of their companies. At their broadest, the duties are designed to ensure that directors act with loyalty and good faith.
Fiduciary duties govern the conduct of directors, but what about when they leave?
Of course, there’s no question that fiduciary duties are binding on company directors. But what happens to those duties when a company director resigns? Such a scenario creates a complex legal position. It’s not reasonable for directors to be bound indefinitely to standards of commercial conduct that are more rigid than those imposed on others. But, by the same token, companies require some degree of assurance that former company directors won’t irresponsibly use the sensitive information they possess.
The Corporations Act sets the standard of directorial conduct
That assurance is offered by sections 183 and 184(3) of the Corporations Act, which governs directorial conduct even after directors leave. Those provisions also ask to whose liberty should the law give precedence: company directors, or companies? Section 183 deals with information directors obtain because they were a director. Specifically, if such information is used to the detriment of a company, or the advantage of the director, that director has committed an offence. However, finding an offence under section 183 requires distinction of the information in question. Was it obtained because the director was a director, or was it simply information or expertise that a competent director would possess? The latter information is generally free to be used at the resigning director’s discretion. However, there are certainly times where it is difficult to distinguish the two.
Easier to consider is section 184(3), which deals with dishonest use of information by former directors. Directors will be liable for a breach of section 184(3) if they dishonestly use information they obtained because they were a company director, for the purpose of gaining an advantage for themselves. The effect of sections 183 and 184(3) is to impose a clear standard of conduct on directors, even after they leave a company.
For the most part, both provisions do so very well. But there are times when it’s not so clear. After all, directors gain valuable experience in their role, which will no doubt be used to their advantage in future positions. The question is, then: does professional experience, for example, amount to information obtained because of a director’s position? And if so, should directors be restrained from applying their professional experience for their own benefit? Generally, the law will answer no to both those questions; professional experience is seen more as something competent directors develop of their own accord. But it’s not always clear. So let’s take a look at what the Court said in the decision of Advanced Fuels Technology Pty Ltd v Blythe & Ors ]2018] VSC 286 in relation to post-service fiduciary duties.
Fiduciary duties also remain after resignation, but their scope is limited by the facts
The 2018 decision of Advanced Fuels Technology Pty Ltd v Blythe & Ors ]2018] VSC 286 observed that fiduciary duties still exist when a director departs a company. However, that is not to say the departed director is restrained from engaging in competitive commercial conduct altogether. In fact, the defendant in Advanced Fuels Technology Pty Ltd did just that. He established a company in competition with the company of which he was previously director.
The Court acknowledged that, while still in effect, the scope of the departed director’s fiduciary duties was relatively limited. The basis of that finding was circumstance; assessing the perceived breach was a question of fact, according to the Court. That means every case needs to be assessed on its own merits. If there is evidence that a departed director has engaged in particularly egregious conduct to the disadvantage of his or her previous company, the Court may feel compelled to enforce the duty. But if a departed director validly pursues competitive commercial ventures, utilising his or her knowledge of a field, Courts are less likely to find a breach.
Restraint clauses are a more definitive way to restrain former company directors
It is not common to see cases like Advanced Fuels Technology Pty Ltd. More often, former directors who engage in such conduct will be pursued for a breach of contract. When directors agree to direct a company, they often sign a contract for service. That contract has many similarities to an employment contract. It is enforceable, and it sets out the terms of the commercial relationship that is being established. More often than not, those terms include restraint. Restraint clauses are applied to directors in the same way they are often applied to employees, partners, and even contractors.
By their nature, restraint clauses restrict the conduct of people and organisations. As a result, they are often contested. That means the law surrounding restraint clauses has been thoroughly interpreted; it is quite well established. Generally, there is a legal presumption that restraint clauses are voidable. However, that presumption can be – and often is – rebuttable. If successfully rebutted, the restraint clause will be effective and binding. Usually, for that reason, restraint clauses achieve their purposes. So how can the presumption of voidability be rebutted?
The restraint clause has to be reasonable
To rebut the presumption that a restraint clause is voidable, the rebutting party must prove that it is reasonable. That means that a company seeking to restrain a former director will need to prove that the subject restraint is reasonable. In a legal sense, reasonableness is a balance. It is a balance between the protection of public interests, and private interests. Essentially, then, a reasonable restraint is one that protects the company’s bona fide interests, without unduly or excessively restricting its former director.
There are three factors that assess reasonableness in restraint clauses
When trying to strike the balance between protecting company interests, and directors’ liberty, the Court looks at three factors. The first is geographical area; the second is duration; and the third is conduct. The Court must ask: what is being restrained, where is it being restrained, and for how long is it being restrained? It is uncommon that a restraint clause will extend beyond the reasonable limits imposed by those questions. Provided a restraint clause does not cover too broad a field of conduct, in too expansive an area, for too long, the presumption of voidability will be rebuttable. Generally, restraints are intended to restrict acutely damaging behaviour, of which there is a naturally limited scope. After all, there are only so many ways a former director can use sensitive information to a company’s detriment. As a result, restraint clauses – provided they are of a reasonable scope – usually take effect over former directors.
Restraint clauses and company directors: what are the important takeaways?
We’ve established that former directors are bound by fiduciary duties. We’ve also established that they may be bound by restraints of trade. But what are the exact parameters of those boundaries? Fiduciary duties effectively impose a boundary of good faith. Although it would be hard to prove a breach of fiduciary duties in a former director, it may be done in circumstances of fraud or dishonesty.
Restraints vary depending on their terms. But generally, they restrict whether former directors can:
- Employ their former colleagues;
- Contract with their former company’s suppliers;
- Utilise inside knowledge they gained by virtue of their position; and
- Form or direct companies that compete directly with their former company.
That’s not an exhaustive list, but it does cover the conduct most often managed by restraints. If you have recently resigned as a company director, you may be affected by similar restraints. If that is the case, contact Kafrouni Lawyers; we can help you come to terms with the terms of your contract. We can also help you establish your new company. Alternatively, we can help draft an effective contract between your company and its director, to help safeguard your company against unfair competition in the future.
Disclaimer
The information provided by Kafrouni Lawyers is intended to provide general information and is not legal advice or a substitute for it. Business people should always consult their own legal advisors to discuss their particular circumstances. Kafrouni Lawyers makes no warranties or representations regarding the information and exclude any liability which may arise as a result of the use of this information. This information is the copyright of Kafrouni Lawyers.
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