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Restraint of trade is ineffective – limited circumstances when it is valid in law.

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Picture this:

You wish to start a new company with a few of your colleagues. You realise that with your know-how and knowledge plus the help of your colleagues, your new company would offer a similar but better service that will cause a splash in the current market.

However, you cannot help but feel worried. A clause in your employment contract appears to be a stumbling block to your dreams moving forward. It reads:

“Non-competition

You shall not, subject to the written consent of the Company, be engaging, directly or indirectly or be interested in any other competing activities, in any capacity during your employment and in the period of two years from the date you cease employment with the Company.

You will not, subject to the written consent of the Company, solicit or entice the customer other than for the benefit of the Company at any time during your employment and in the period of two years from the date you cease employment with the Company.”

Are you are barred from competing against your employer? Have your dreams been effectively dashed?

As the title of the clause suggests, a restraint of trade clause (otherwise also known as a non-competition clause) is often incorporated into an employment contract to estop an employee from becoming a competitor of the company, whether by starting his/her own company or joining a rival, carrying out an identical or similar trade to that of the company.

Whilst such a clause serves to protect the interests of a company/employer, generally speaking, the same cannot be enforced in Malaysia because of Section 28 of the Contracts Act 1950 (“CA 1950”) which states:

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

There are, however, limited circumstances where a restraint of trade clause is valid and/or enforceable. These are found in the exceptions provided under Section 28 of the CA 1950, where:

Exception 1 – When goodwill is concerned

“One who sells the goodwill of a business may agree with the buyer to refrain carrying on a similar business, within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein:

Provided that such limits appear to the court reasonable, regard being had to the nature of the business.”

Exception 2 – When a partnership is dissolved

“Partners may, upon or in anticipation of a dissolution of the partnership, agree that some or all of them will not carry on a business similar to that of the partnership within such local limits as are referred to in exception 1.”

Exception 3 – When a partnership continues to subsist

“Partners may agree that some one or all of them will not carry on any business, other than that of the partnership, during the continuance of the partnership.”

Effectively, this means that an entity cannot prevent an ex-employee from incorporating, joining and/or continuing a competing business unless it falls under the three exceptions under Section 28 of the CA 1950. In this regard, in Polygram Records Sdn Bhd v Hilary Ang & Ors (Collectively known as “The Search”) & Anor [1994] 3 CLJ 806held that:

[5] The convenant whereby the defendants undertook to provide exclusive recording rights to the plaintiffs during the currency of their recording contract, is not a covenant in restraint of trade and is therefore not rendered void under s. 28 of the Contracts Act. Section 28 is only applicable in cases where a person is restrained from carrying on his trade or profession in the traditional sense of the doctrine, that is, in the post – contract period and not during the currency of the contract.

[6] The tenor of clause 6 (v) is clearly that of a covenant in restraint of trade in the traditional sense. Whilst the validity of such convenants are tested by the reasonableness test by the English Courts, the position in Malaysia is different. Once the Malaysian Courts take the view that a particular covenant is a covenant in restraint of trade, the Courts, have no discretion, but to declare it to be void under s. 28 of the Contracts Act, subject to the three exceptions provided for by the said section. As none of these exceptions are applicable to the instant case, and having held that clause 6(v) is a covenant in restraint of trade, clause 6 (v) is void and of no effect. As it is a void provision, it should further be deemed to be void ab initio, that is, from the time the second contract was entered into.

The position of the law was further reiterated in the recent case of Ace Capital Growth Sdn Bhd v Kua Kee Koon[2021] 1 LNS 1846 where the Court held:

[18] At the outset, there is no dispute that the terms and conditions of employment clearly imposed a restraint of trade period of 8 months in Malaysia whereby it provides that D1 will not directly or indirectly work for a direct competitor.

[19] However, in my view, there is certainly merit in the Defendants’ submission that such a restraint of trade clause is rendered void by Section 28 of the Contracts Act 1950.

[20] it is now accepted that an ex-employer cannot prevent a previous employee from using skill and knowledge in his trade or profession which he has learnt in the cause of his employment. Such know how is different from secret or confidential information. See the cases of VSL Prestressing (Australia) Pty Ltd v. DJ Mulholland [1971] 2 MLJ 89 and Svenson Hair Center Sdn Bhd v. Irene Chin Zee Ling [2008] 8 CLJ 386; [2008] 7 MLJ 903

Why then would companies include restraint of trade clauses in the first place, if they are generally inadmissible?

Whilst it is trite that an employer cannot restrain an ex-employee from using the skill and knowledge gained during employment, it does not follow that such knowledge and know-how of a particular field gained extends to divulging or misusing a company’s trade secrets and/or confidential information.

Cases such as Ace Capital Growth and Worldwide Rota Dies Sdn Bhd v Ronald Ong Cheow Joon [2010] 8 MLJ 297 have shown that a restraint of trade clause may be valid and enforceable if the effect of such a clause prevents a company’s trade secrets and/or confidential information from being divulged or misused.

[116] It is my judgment that a restraint is permissible if it is fashioned in such a way as to prevent a misuse of trade secrets or business connexion. Here, the restriction extended to Singapore, Thailand, Indonesia, Philippines and Taiwan including Malaysia. In E Underwood & Son Ltd v Barker [1899] 1 Ch 300, the restriction extended throughout the United Kingdom and it was allowed. In Lamson Pneumatic Tube Co v Phillips (1904) 91 LT 363, the restriction to the Eastern Hemisphere was regarded as reasonable.

[118] The defendant was put in a position of acquiring special intimate knowledge of the clients of the plaintiff thereby allowing the defendant the opportunity of exercising influence over them, and surely in such a situation the plaintiff was entitled to obtain the court’s protection. I share the sentiments of Evershed J, in Routh & Anor v Jones [1947] 1 All ER 179, at p 181, to the effect that:

… the master would be exposed to unfair competition on the part of his former servant — competition flowing not so much from the personal skill of the assistant as from the intimacies and knowledge of the master’s business acquired by the servant from the circumstances of his employment.

It ought to be noted that in Malaysia, confidential information and/or trade secrets have not been statutorily defined. However, in the case of Medien Sdn Bhd v. Dominic Chai Le Seng [2019] 1 LNS 2017, the Court approved the definition expounded in Saltman Engineering Co. Ltd v. Campbell Engineering Co. Ltd [1963] 3 All ER which held that:

the information, to be confidential, must, I apprehend, apart from contract, have the necessary quality of confidenceabout it, namely*, it must not be something which is public property and public knowledge.** On the other hand, it is perfectly possible to have a confidential document, be it a formula, a plan, a sketch, or something of that kind, which is the result of work done by the maker on materials which may be available for the use of anybody; but what makes it confidential is the fact that the maker of the document has used his brain and this produced a result which can only be produced by somebody who goes through the same process.”*

Similarly, in Svenson Hair Care Centre Sdn Bhd v. Irene Chin Zee Ling [2008] 8 CLJ 386, the court held that customers’ names, lists and details have also been judicially recognized as being confidential, and wrongful utilization of such particulars warrants injunctive protection.

Put simply, an ex-employee with access to confidential information cannot be prevented from starting or continuing to work in a new company, but he/she would certainly not be allowed to divulge any confidential information and/or trade secrets to anyone.

However, does that mean that you can solicit customers and clients from your old company?

It is settled law that the answer is a clear negative**.** In the case of Schmidt Scientific Sdn Bhd v Ong Han Suan & Ors [1998] 1 CLJ 685, it was held that it is a breach of duty of fidelity and good faith on the part of the employee to remove a customer list or to deliberately set out to memorise the said list to use it later, even though any use or disclosure is confined to the post-employment period,  with the intention of using it to solicit orders from them after he had left his employer’s service and set up a similar business on his own account.

In the case of Thomas Cowan & Co Ltd v. ORME [1960] 1 LNS 155, the court stated that:

“Now the first point for consideration is, what are the interests of the employer that are to be protected? If the only object of the covenant is to restrain competition and nothing else then it will not be protected. The employer is undoubtedly entitled to have his interest in his trade secrets protected. He is also entitled not to have his old customers enticed away from him by solicitation or such other means. In this case evidence was adduced as to the nature of the plaintiffs’ business, as to the employment of the defendant prior to joining the plaintiffs, and as to the duties involved by the position which the defendant occupied in the plaintiff company. I find that the defendant, by reason of his employment by the plaintiffs, acquired special knowledge and became acquainted with the trade secrets and information relating to the business of the plaintiffs and he is in a position to entice away the customers of the plaintiffs. In fact he has already enticed away one customer of the plaintiffs by offering prices lower than that of the plaintiffs and in two cases he had by letter solicited the custom of persons who were customers of the plaintiffs.”

To conclude, your dream of starting a new company with your colleagues may very well be a worthwhile pursuit permissible by law – one that may not be prevented by a restraint of trade clause, but be mindful to not risk:

  1. Divulging confidential information and/or trade secrets gained during your previous employment; and
  2. Soliciting the company’s customers and clients within the post-employment period stated in your contract of employment.

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