What does the Non-Compete Clause in your Contract mean? PART 1

Introduction 

Can an employer prevent its employee from working for their competitors for a period of time after the termination of the employee’s contract? This is a type of restraint of trade clause. More specifically, a non-compete clause. A traditional non-compete clause would probably look like this: -

“You agree to not join any company, whose trade/business is similar or the same as ours for the next 6 months upon termination of your employment with us”

The phrase ‘restraint of trade’ was first defined in the English authority of Petroline (GR Britain) Limited v Martin and Another [1966] 1 All ER 126 as:

“A contract in restraint of trade is one in which a party agrees with any other party to restrict his liberty in the future to carry on trade with other persons not parties to the contract in such manner as he chooses” 

Essentially, restraint of trade clauses are used to prevent competition by restraining one from engaging in a particular trade or business.

Are Non-Compete Clauses Enforceable?

Non-compete clauses are not inherently illegal. If a court declares that a non-compete clause is void, it is usually based on the principle that it constitutes restraint of trade.

Briefly, the common law position is that all restraints are prima facie void unless it is shown that the restraint is reasonable in the interests of the parties and of the public. The House of Lords in Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co. [1894] AC 535 held that a restraint of trade is not void “… if the restriction is reasonable – reasonable, that is, in reference to the interests of the parties concerned and reasonable in reference to the interests of the public…”

However, in Malaysia, under Section 28 of the Contracts Act 1950, all restraint of trade clauses are prima facie void unless it falls within any one of the three exceptions provided therein. 

s.28 CA 1950
“Every agreement by which anyone is restrained from exercising a lawful profession, trade, or business of any kind, is to that extent void.”

• Exception 1: Agreements that involve sale of goodwill of a business
• Exception 2: Agreements between partners prior to the dissolution of a partnership
• Exception 3: Agreements during the continuance of a partnership.

Exception 1: One who sells the goodwill of a business may agree with the buyer to refrain carrying on a similar business, within specified local limits provided that such limits appear to the court reasonable.

It is pertinent to note that the position in s.28 significantly differs to the common lawposition. In this regard, pursuant to s 28 CA 1950, all restraint of trade is void unless it comes within the three exceptions provided. However, common law (particularly in the United Kingdom) has referred to the test of reasonableness in determining whether an agreement restrains trade.

This was first propounded in the case of Nagadevan A/L Mahalingam v Millenium Medicare Services [2011] 4 MLJ 739, wherein the Court of Appeal allowed Nagadevan’s application to strike out Millenium Medicare’s suit which was deemed to have a restrictive covenant in the agreement post-employment. In doing so, the Court of Appeal held that “the validity of such covenant is not subject to the ‘reasonableness test’ under the common law”, thus, making s.28 and the exceptions thereto an exhaustive provision.

Subsequently in Vision Cast Sdn Bhd & Anor v Dynacast (Melaka) Sdn Bhd & Ors [2015] 1 MLJ 424, the Court of Appeal was tasked to determine whether the execution of a confidentiality agreement and deed of restrictive covenant during employment was valid under Exception 1 of s.28. The Court of Appeal held that no restraint was allowed against the Appellant involvement in any competing business or in dealing with Dynacast’s customers after the end of the contractual period and any restraint against the Appellant from pursuing lawful trade/business was unsustainable and should be struck down by s.28. 

However, the Court of Appeal took a step further to consider the applicability of the ‘test of reasonableness’ by comparing s.28 to Section 27 of the Indian Contracts Act, which is similar to the Malaysian legislation, save as for Exceptions 2 and 3, which are not found in the Indian legislation. To this end, the Court of Appeal was of the considered view that the reasonableness test should apply only to Exception 1 of s.28.

“[129] In considering what is said to be reasonable between the parties, reference to the case of Esso Petroleum Co Ltd v Harper's Garage (Stourport) Ltd [1968] AC 269 (HL), should be made. In that case, Lord Reid remarked that where a party, who is in no way at a disadvantage in bargaining, chooses to take a calculated risk, then His Lordship could see no reason as to why the court should say that he had acted against his own interests. In that case too, Lord Hodson remarked that in the case of agreements between commercial companies in regulating their trade relations, the parties are usually the best judges of what is reasonable.”

- Worldwide Rota Dies Sdn Bhd v Ronald Ong Cheow Joon [2010] 8 MLJ 297

Further, s.28 provides that the agreement is “to that extent void”. The judiciary have interpreted this to mean that where non-compete clauses are deemed to be void,other provisions in the agreement remain valid and binding against the employee.Therefore, the Courts will not strike down the entire contract. 

While Non-Compete Clauses (“NCCs”) applying Exceptions 1 and 2 to s.28 are valid post-employment, NCCs applying Exception 3 may be applicable during the contractual period, as expounded in Polygram Records Sdn Bhd v The Search & Anor [1994] 3 MLJ 127 (this will be dealt with in more detail in Part 2 of this Article).

Thus, if the court is of the view that a non-compete clause that applies after the contract period constitutes a restraint of trade, the non-compete clause must fall within one of the exceptions to s.28 in order for it to be enforceable against anemployee. 

When a non-compete clause does not fall squarely within the exceptions laid down in s.28 CA 1950, an employer cannot enforce it against an employee, unless the Courts find that it is reasonable to do so. 

Conclusion 

In short, while an employee is still under employment, he is prohibited from having any direct or indirect interest in a rival company prior to the termination of hisemployment. 

In Part 2 of this Article, we will discuss the applicability of Exceptions 2 and 3 to s.28 of the Contracts Act 1950.