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EFFECTIVE RESTRAINTS OF TRADE AND THE ADDED PROTECTION OFFERED BY A PENALTY CLAUSE

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Published Date: May 27, 2024

It has been said that “restraints of trade are not worth the paper they are written on”. This is far from the truth as many employees have learnt, the hard way. Not only are valid restraints of trade enforceable, but they are also enforced regularly by the Courts. The consequences for the former employee can be dire. In addition to suffering the consequence of the restraint (i.e. being precluded from taking up employment with a competitor), the former employee is usually ordered to pay the legal costs incurred by the employer in the enforcement litigation.

Although enforcement of valid restraints of trade are commonplace, awards for damages against former employees are less frequent. It is not because the Courts do not recognise that breaching of a restraint renders the former employee liable, but rather because it is difficult to quantify damages for such breaches, and therefore sometimes not worth the effort and legal costs that would have to be incurred. A partial solution to this problem is to insert a penalty clause into employment contracts. The clause would stipulate a penalty that will become payable in the event of a breach.

A penalty clause saves the employer the hassle of having to prove damages in the event of a breach. The damages that would be payable in the event of a breach of the restraint of trade clause are set in advance, with the effect that once a breach is established, the damages become payable.

Penalty clauses are subject to the Conventional Penalties Act. The Act allows a penalty debtor (i.e. the person having to pay the penalty) an opportunity to persuade the Court that the penalty is disproportionate to the prejudice suffered by the innocent party, and to seek a reduction of the penalty payable to ensure proportionality and fairness. The onus to demonstrate that the penalty is out of proportion to the prejudice, rests with the debtor. If the debtor cannot show that the penalty is disproportionate to the prejudice suffered, the penalty will be enforced.

In the recent case of Braddon Mc Cleland (Pty) Ltd t/a Network Associates v Calvin Le Roux, an appeal to the full bench of the Makhanda High Court, a penalty clause in an employment agreement was considered and enforced. The penalty clause provided that in the event of a breach of the restraint, the employee would be liable for a penalty equal to 12 months’ salary.

In considering the appeal, the Court held that the need of an employer to protect its trade connections arises where the employee has access to customers and is in a position to build up a particular relationship with customers so that when he leaves the employer’s service, he could easily induce the customers to follow him to a new business: “the employee, by contact with the customer, gets the customer so strongly attached to him that when the employee quits and joins a rival he automatically carries the customer with him in his pocket”. It was established that the erstwhile employee was trained in the art of fostering customer relationships. He was also employed as the customer relations manager with the specific task of developing and fostering relationships with clients and gained intimate knowledge of the needs and requirements of the employer’s clients, some of whom, he got to know personally. After he left, he utilised those personal relationships to sell alternative services to his erstwhile employer’s customers.

In considering the former employee’s plea that the amount payable in terms of the penalty clause should be reduced, the Court held that approaching the customers he had previously dealt with constituted a serious intrusion into the customer relations of his former employer, and that there was no reason not to enforce the penalty.

Penalty clauses could serve as a deterrent and provide employers with effective protection in addition to the recourse that is available in terms of restraint of trade clauses.

It is difficult at the time of setting the penalty, to estimate the damages that would flow from a breach of the restraint, and there is accordingly a risk that the stipulated penalty would be too low to compensate the employer for the actual loss. To mitigate this risk, employers could consider stipulating that in the event of a breach it would have the choice to claim the penalty, alternatively, the actual damages suffered.

Jac Marais
Partner | Litigation Attorney

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