It is common for an employee to start a business that is similar to his former company’s after leaving the company.
After all, the employee has gained skills and knowledge in the business of the company during his time with it, and now merely wishes to earn money through those skills and knowledge for himself, as opposed to for the company.
Most of the time, this is legal, normal, and even encouraged, as they present healthy market competition that is beneficial to the consumers.
It is also a natural progression of many employees’ career, i.e. upgrading from an employee to a boss.
Are Employees Always Allowed to Do So?
However, sometimes this transition of employee-to-competitor may be utterly unfair to the former employer / company.
For example:
- when the employee uses confidential information of the former company such as its client list or trade secrets to springboard the employee’s new company – unlawful interference with trade/breach of confidence; or
- when the employee poaches all key employees of the former company to leave the former company and join the employee’s new company, thereby crippling the former company – team moves.
At the same time, it may equally be unfair to allow a company to perpetually restrain an employee from being involved in a similar business after he leaves the company – non-compete clauses, as an insidious way of preventing competition,
Thus, in these situations, laws must intervene to prevent unfairness or anti-competition practices.
Unlawful Interference with Trade, Breach of Confidence, Team Moves, and Non-Compete
This article is the 1st of a mini series, that addresses the laws surrounding these issues, and seeks to provide guidance to companies on how to legally protect their interests from such employees-turned-competitors.
This article will first address the legality of non-compete clauses, whilst unlawful interference with trade, breach of confidence, team moves, and the legal & practical solutions to these issues will be addressed in parts that will be published soon.
What Are Non-Compete Clauses?
Non-compete clauses are clauses in an employment contract that prohibit an employee from participating in a business or trade similar to the employer’s after the employee leaves the employer.
Often, such restrain in competition are demarcated by geographical area or limited by a time period.
For example, the non-compete clause may prohibit the employee from setting up a similar business within 10km radius of the former company, or within 1 year from his resignation from the former company.
However, are these Non-Compete clauses legal?
The simple answer is no.
Non-compete clauses in employment contracts are not enforceable in Malaysia pursuant to Section 28 of the Contracts Act 1950.
Section 28 states that “every agreement by which anyone is restrained from exercising a lawful profession, trade, or business of any kind, is to that extent void” subject to three exceptions. The exceptions are:
- Agreements involving sales of goodwill of a business;
- Agreements between partners prior to dissolution; and
- Agreements between partners during the continuance of the partnership.
This list of exceptions is exhaustive (see Nagadevan a/l Mahalingam v Millenium Medicare Services [2011] 4 MLJ 739) and Courts are not to read new exceptions into the law.
An interesting case that discusses this provision is the High Court case of Polygram Records Sdn Bhd v The Search & Anor [1994] 3 MLJ 127.
Facts:
The Plaintiff is a music and sound recording company. The first five Defendants are members of a group of musicians, known as The Search.
On 7 October 1984, the Plaintiff entered into a written agreement with to produce music records. Eight months after the first contract was entered into, the Plaintiff felt the need for a new contract to be entered into as there were some changes in the composition of The Search. On 12 June 1985, a new contract was subsequently entered into between the Plaintiff and the Defendants.
The circumstances under which the two agreements were entered into were very unsatisfactory.
After February 1987, the Defendants were unhappy with the existing arrangements with the Plaintiff, such as on the royalty rates and that they were not presented with any gold or platinum award by the Plaintiff At the end of 1987, the Defendants made the recording of an album in Jakarta under a new company, Go-search.
Go-search was incorporated by the member of The Search, ie the first five Defendants themselves. Go-search did only the recordings, whilst another company, PMC (the sixth defendant) did the distribution.
The Plaintiff commenced the court action for amongst others, breach of contract and injunctions against the Defendants. The Defendants counterclaimed inter alia to declare both agreements null and void.
Court’s Ruling:
The Court held, amongst others, that the covenant 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 Section 28 of the Contracts Act.
The Court held that 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.
Further, the Court made it clear that once a Court takes the view that a particular covenant is a covenant in restraint of trade, the Court has no discretion but to declare it to be void under s. 28 of the Contracts Act and does not concern itself with the “reasonableness” of the clause.
Additionally, if it is void, the clause is void ab initio, that is, from the time the second contract was entered.
In Summary
Based on this, it is clear that a clause that restrains a party, including an employee, from working for a competitor during his employment with the current company, is a usual, acceptable, “exclusive service” clause. It does not fall within the meaning of Section 28 and therefore is not void.
Instead, Section 28 is applicable on clauses that restrain, usually, participation of a trade in the post-contract period, i.e. clauses that prohibit the employee from participating in a similar business after leaving the employment.
Clauses that restrain the post-termination period, are void pursuant to Section 28.
Conclusion
In conclusion, subject to very limited exceptions, an employee post-employment non-compete clause is not workable in Malaysia.
Therefore, employers who insert these clauses in their employment contracts, are advised to review them and see if they fall squarely within the ambit of Section 28 of the Contracts Act and thus void. Employers should also seek legal advice to see if these clauses can be re-drawn or changed so that they avoid the application of Section 28 but still helps Company achieves a similar objective.
In any event, this does not mean there is no way from preventing unfair practices by former employees who turned competitors, or that when wronged by unlawful acts by former employees-turned competitors, the company has no recourse.
The company can amongst others, take civil action to seek compensation and injunctions.
These will be addressed in the subsequent parts of this mini-series.
Stay tuned.
If you need further advice on anti-competition / non-compete clauses, feel free to Contact Me
Authored with the assistance of my able interns – Sueeny Soon, and Genevieve Ling.