Ipsofactoj.com: International Cases [2001] Part 4 Case 6 [NZCA]


COURT OF APPEAL, NEW ZEALAND

Coram

Fletcher Aluminium Ltd

- vs -

O’Sullivan

GAULT J

KEITH J

TIPPING J

20 MARCH 2001


Judgment

Gault J

  1. Mr. O'Sullivan applied to the Employment Court for a declaration that a restrictive covenant contained in his contract of employment with Fletcher Aluminium Ltd ("the company") is unenforceable. He applied also to restrain enforcement of the covenant.

  2. In a judgment delivered on 21 November 2000 Judge Colgan held that the covenant was unreasonable and therefore unlawful, but he exercised the power in s 8 of the Illegal Contracts Act 1970 and modified the covenant. This appeal is against that decision.

  3. The company is a major participant in the aluminium joinery industry in New Zealand. Primarily for historical reasons, its business involved the manufacture and marketing of a number of different brands of aluminium joinery through franchised fabricators. As is typical in the industry, as the primary manufacturer (referred to in the industry as the prime die holder), it was responsible for the design and manufacture of the aluminium extrusions and other components of the joinery. Those components were fabricated into doors, windows and the like by the fabricators using the extrusions and tooling provided by the manufacturer.

  4. Although the success of the business ultimately depends upon the acceptability of the designs, and services in providing the joinery to the construction industry, the prime die holders compete for contractual links with fabricators who are the conduits to the wider market. The company had some 100 contracted fabricators throughout the country handling its various brands of joinery. In total there are between 300 and 350 fabricators in New Zealand.

  5. By 1998 the company had become concerned for the need to rationalise its product range, particularly since its established brands of joinery were a good many years old. Rationalisation of product lines presented problems in the retention of the loyalty of contract fabricators for the various brands. The company learned that Mr. O'Sullivan, who had experience in the industry with one of the company's competitors and was known to be well connected with fabricators throughout the country, was offering to a competitor designs of a new range of aluminium joinery. This presented the company with an ideal potential solution to its problem in that it would provide a new aluminium joinery system which could be offered to all fabricators as replacement for the various established brands. The company therefore entered into negotiations with Mr. O'Sullivan.

  6. After quite extensive negotiations the parties concluded an agreement on 30 March 1999. In form this was an agreement for the sale and purchase of "intellectual property" defined as meaning all inventions (whether patentable or not), designs, copyright, formulae, techniques, know-how, trade secrets and all other intellectual property relating to and associated with the products. The products were identified in a schedule to the agreement and comprised three different door and window suites, a premium front entry door suite and a ballustrading system. The agreement provided for disclosure of Mr. O'Sullivan's drawings progressively upon incremental payments on terms that the company would not become committed to development of the designs until satisfied from inspection of the drawings. There were quite complex provisions designed to protect Mr. O'Sullivan from loss of secrecy for his designs should they not be taken up for development by the company and to protect the company from commitment to extensive development until satisfied of the commercial suitability of the designs and their originality.

  7. It transpired that the designs proved acceptable to the company and payments totalling $1.7 m were made to Mr. O'Sullivan. It was acknowledged in the agreement that at the time of settlement the designs of the products were not complete but were in varying stages of development described as between 5 percent and 90 - 95 percent complete. The company undertook to use its best endeavours at its own cost to protect the designs by registration. There were provisions requiring the preparation of drawings and sample windows for presentation to franchisees within 35 business days of settlement with provision for termination in the event that the products proved unacceptable. There were also elaborate confidentiality provisions.

  8. The agreement provided that in consideration of the company entering into the agreement Mr. O'Sullivan would enter into an employment contract in the form annexed to the agreement. The form of individual contract of employment provided for the appointment of Mr. O'Sullivan to the position of Franchising Development Manager. The remuneration was by way of a base salary of $85,000 (subject to annual reviews), a vehicle or a vehicle allowance and commission based on the invoiced price of products sold to new franchisees of the company. A schedule of duties was provided. The schedule required Mr. O'Sullivan to work with the product development team in completing the design of the products, to assist with the protection of the designs, to develop a franchising strategy for the company and in particular a conversion plan and framework for the integration of new franchisees. It is plain that the contract envisaged that Mr. O'Sullivan would have a leading role in the development of the products, promotion of them to franchisees, conversion of existing franchised fabricators and extending to "leading project teams as required on the launch of the products" and "ongoing involvement .... in product development".

  9. The agreement incorporated the following restraint of trade clause:

    Restraint of Trade

    In consideration of the Company agreeing to pay you the commission payable under this contract and agreeing to enter into the Agreement, you agree:

    (a)

    not to be involved in any business which competes or is likely to compete with the Company in the design, marketing, sales or distribution of windows or doors in New Zealand, for a period of two years from the date of termination of your employment;

    (b)

    not to solicit or entice the business, custom or employment of any person who is or was in the two years preceding the termination of your employment, a customer, supplier, client or employee of the Company, for a period of two years from the date of termination of your employment.

  10. The "Agreement" specified in the second line as the consideration for the covenant is defined as the agreement for sale and purchase of the designs.

  11. For reasons that are disputed and are the subject of dispute resolution proceedings with which we are not concerned, Mr. O'Sullivan terminated his employment with the company on 19 September 2000 claiming constructive dismissal.

  12. Mr. O'Sullivan is 38 years of age and has a Bachelor of Commerce with Honours in Marketing. In his statement of evidence in support of his application to have the restraint covenant declared unenforceable he stated that if he is required to observe the covenant he will, in effect, be prevented from working in his area of expertise and chosen field. He said he wants to be able to work for a prime die holder and help fabricators compete and grow their businesses. He also said that he believes he will have no difficulty securing employment in New Zealand because of interest from two of the four existing prime die holders previously expressed.

  13. In the judgment under appeal Judge Colgan described the background leading up to the execution of the contracts and set out in some detail evidence of the negotiations between the parties. He referred particularly to the circumstances in which the covenant came to be included in the contract. 

    He said:

    As distinct from the restraint’s content, the events leading to and surrounding its agreement confirm an equality of bargaining power and a history of fair dealing. The clause was included in drafts of the contract exchanged, considered and amended for at least several weeks before it was signed. Mr. O’Sullivan took legal advice about the restraint. His legal advice in this and other respects was paid for by FAL. There was an amendment by way of deletion to the restraint sought by Mr. O’Sullivan and agreed to by FAL.

    Mr. O’Sullivan was aware of the nature and effect of such restraints. There was no inequality of bargaining power in favour of FAL. Indeed, at the latter stages of negotiation any relevant inequality of bargaining power was in Mr. O’Sullivan’s favour. He had valuable designs that FAL was anxious to acquire.

  14. The Judge then addressed relevant contractual provisions, stating that in determining the reasonableness of the restraint, the relevant contractual provisions must be considered. He referred to the terms of the employment contract. He then accepted the submission made on behalf of the company that the employment contract is effectively inseparable from the contract for sale and purchase of the designs and said:

    Whilst it means that more contractual factors than were contained in the employment contract must be considered, it also confirms that the designs in the new suites were sold to FAL and, with proper statutory protections now being put in place, Mr. O’Sullivan is legally and practically precluded from recourse to those designs or imitations of them.

    Clause 19 of the agreement for sale and purchase (and thereby the employment contract) contains express constraints upon the misuse of Mr. O’Sullivan of confidential information in addition to the intellectual property protections FAL has through patent and design registrations.

  15. The Judge then referred to the law. He noted that it was common ground that the restraint was unenforceable unless the company established its reasonableness from the point of view of the employer, the employee, and the general public. He noted that reasonableness must be determined at the time the covenant was entered into, and referred to the recent decision of this Court in Gallagher Group Ltd v Walley [1999] 1 ERNZ 490, 496. He referred to the need to consider what the parties might reasonably have foreseen at the time of entering into the contract. No issue is taken with that approach.

  16. The Judge noted that in this case the employment contract is part of the commercial arrangement including the sale of the designs. In that respect he noted the case is not precisely the same as the Gallagher case in which this Court had distinguished the approach required there from the more liberal approach taken by the courts to covenants in restraint of trade imposed upon vendors of goodwill. The Judge then said:

    Here, while there was the concomitant sale by the employee to the employer, there was no sale and purchase of goodwill in which the purchaser’s interest could only be protected by a restraint. What was bought and sold was the intellectual property in designs protected by effective statutory schemes following registration. Vulnerability to misuse of the vendor’s knowledge was principally confined to the pre-registration period. This was, therefore, not a case of a sale of goodwill addressed by the Court of Appeal in Walley. Nevertheless the totality of the transactions between the parties must be taken into account.

  17. It is that paragraph which was the primary focus of the submissions on behalf of the appellant. It will be necessary to return to it.

  18. The Judge referred to the general proposition that the employer cannot protect itself against mere competition. He accepted however that there is an entitlement to protect trade secrets and confidential information but the restraint must be no more than necessary reasonably to protect those interests. He noted that the contractual arrangements included a separate clause prohibiting disclosure of confidential information by Mr. O'Sullivan at any time after the end of employment. He accepted, however, that for the company protection by restraint would be preferable to a right of action for breach of contract after disclosure. The Judge then reviewed the evidence under a heading "The Rationale for the Restraint" in which he referred particularly to reasons advanced by two senior executives of the company for seeking the restraint and for its terms. He then said:

    I accept there were interests FAL was entitled to protect with a restraint other than, and continuing for longer than, those interests it had in the interim protection of its intellectual property in the O’Sullivan designs until patent and registered design protections were in place. FAL’s other valid interests included Mr. O’Sullivan’s knowledge of a computerised information technology system known as "Alexsys". Mr. O’Sullivan had participated in the revision of this to enable the 35-millimetre suite to be costed. Likewise, the plaintiff knew of confidential tooling issues for the new suite. The case for FAL also established Mr. O’Sullivan was aware of confidential pricing structures and margins, sensitive commercial information of value to competitors. The plaintiff was also aware of re-designs of manufactured product and systems following development of the new suites designed by him.

  19. The Judge then made findings concerning the period the contracting parties had envisaged would be involved in bringing the new joinery suites to the market, that is until the designs were disclosed publicly. He referred to a claim that the company would be particularly vulnerable to competition during that period and said:

    It was reasonable for it to be protected by some restraint so Mr. O’Sullivan would not compete at a time when his designs were being launched. The position would, however, be different following the launch of those products to existing FAL fabricators.

    Mr. Eglinton’s evidence was also that an important objective of the restraint was to protect FAL’s $1.7 million investment in the intellectual property in Mr. O’Sullivan’s designs purchased from him. I accept such was a reasonable justification for a restraint but only for the period until the statutory protective regimes of patent and design registration could take effect.

  20. In the result, after considering the need for the restraint to apply in respect of suppliers, and having found the geographical extent of the restraint to be reasonable having regard to the nature of the industry, the Judge determined to modify the covenant by excluding the reference to suppliers and by limiting its duration. Focusing on the period of restraint after termination of the employment he said:

    The other period is that during which the plaintiff is not to compete or solicit or entice business or employment, the unalterable period of two years defined only by its commencement at the cessation of the employment. This period is at the heart of the case and is, by virtue of its fixed duration and for reasons set out elsewhere in this judgment, unreasonably long in all the circumstances. Whilst a two year long restraint may have been justifiable in the early period of Mr. O’Sullivan’s employment, the parties’ contractual intentions and expectations were such that a lengthy restraint was unreasonable after that initial period. After allowing a longer restraint period earlier in the contract that would have protected FAL in respect of both the designs it bought and its other confidential information, the remaining question is the reasonable length of a restraint to protect that remaining confidential information to which Mr. O’Sullivan was privy. Both parties focussed their cases upon a global restraint period of 2 years covering all FAL’s protectable interests, but it is unreasonably long for this enduring category of confidential information. After 18 months of longer restraint, the plaintiff’s situation became that of a mid-level manager with knowledge of confidential product, sales and marketing information. On the evidence and taking account of the analysis of other relevant cases summarised in Walley v Gallagher Group Ltd at first instance ([1998] 3 ERNZ 1153, 1187), I find 6 months to be a reasonable ongoing restraint period.

  21. The modified covenant, with the changes emphasised, is as follows:

    1.  not to be involved in any business which competes or is likely to compete with the Company in the design, marketing, sales or distribution of windows or doors in New Zealand, for a period calculated in (c) below from the date of termination of your employment.

    2. not to solicit or entice the business, custom or employment of any person who is or was in the two years preceding the termination of your employment, a customer, (omission), client or employee of the Company, for a period calculated in (c) below from the date of termination of your employment.

    3. The period of two years from 1 April 1999 but reducing by one month for each month of the performance of the employment contract until 1 October 2000 and thereafter the period of six months for the remainder of the contract.

  22. The effect of applying the modified covenant is that Mr. O'Sullivan is subject to the restraint until 19 March 2001.

  23. For the appellant Mr. Miles argued that the Judge's finding that the period of the restraint was unreasonable is wrong. It was submitted that, though he purported to do so, the Judge did not consider the covenant in its full context of a commercial transaction involving the sale of assets for use in the business. It was said further that, by proceeding on the basis that the only supportable ground for restraint was protection of confidential information acquired by Mr. O'Sullivan in the course of his employment, the Judge misconceived the purpose of the covenant and the significance of the intellectual property registrations to be sought pursuant to the agreement. Only the duration of the restraint is in issue on the appeal. The modification deleting the reference to "suppliers" is not challenged.

  24. On the other hand, for the respondents, Mr. Neutze submitted that this Court's jurisdiction is confined by s135 of the Employment Contracts Act 1991 to questions of law, whereas the Judge's finding of unreasonableness rested on a broad factual assessment which cannot be interfered with. It was argued further that, in any event, the Judge applied the correct test and reached the correct conclusion.

  25. In the Gallagher case this Court said (p 495):

    Whether a clause is in its particular circumstances reasonable and thus valid and enforceable is fundamentally a question of law but that can be answered only upon a consideration of the factual setting. The Judge’s assessment of the facts is not to be revisited.

  26. Just as the ultimate determination of unreasonableness is essentially one of law, so are the principles upon which that determination is to be approached. Accordingly, while this Court will not revisit findings of fact, its role is to ensure that they have been made in the correct legal setting and against correct legal principle. That same approach has been adopted in relation to the interpretation of employment contracts which also is reserved by s 135 Employment Contracts Act to the Employment Court — see Air NZ Ltd v Johnson [1992] 1 ERNZ 700, 706, A-G v NZ PPTA [1992] 1 ERNZ 1163, 1169. We approach this case in that way.

  27. It appears from some comments in the judgment that the Judge had in mind two categories of restrictive covenants – those that are entered into to protect goodwill and those that are not. For example he said, after referring to comments in the judgment in the Gallagher case, "[h]ere, while there was the concomitant sale by the employee to the employer, there was no sale and purchase of goodwill in which the purchaser’s interest could only be protected by a restraint".

  28. That the courts have approached restraint covenants entered into at the time of the sale of the goodwill of a business differently from such covenants in employment contracts is clear enough. That was said in the Gallagher judgment and goes back to, and before, the decisions of the House of Lords in Nordenfelt v Maxim Nordenfelt Guns & Ammunition Co [1894] AC 535 and Herbert Morris Ltd v Saxelby [1916] AC 688. The difference derives from the fundamental proposition that a restraint of trade should be no wider than is required to protect the party in whose favour it is given. The purchaser of goodwill requires protection against the erosion of that goodwill. The employer requires protection against an employee taking advantage of the employers trade and commercial information acquired by the employee in the course of employment.

  29. But it is not correct that restrictive covenants are to be confined to one or other of two categories. Nor did the Gallagher judgment say that. In Dawnay, Day & Co Ltd v D’Alphen [1998] ICR 1068, 1106, Evans LJ, with whom the other members of the Court of Appeal agreed, after reviewing the authorities, said:

    In my judgment, far from confining the circumstances in which covenants in restraint of trade may be enforced to certain categories of case, and defining those categories strictly, the courts have moved in the opposite direction. The established categories are not rigid, and they are not exclusive. Rather, the covenant may be enforced when the covenantee has a legitimate interest, of whatever kind, to protect, and when the covenant is no wider than is necessary to protect that interest.

  30. As the decision in that case demonstrates, even where there is no goodwill sold, the covenantee may have a legitimate interest that can be protected by restrictive covenant. In that case the provision of start-up capital for the development of a joint venture company was held to be a sufficient interest to be protected by non-competition and non-solicitation covenants.

  31. In the present case the Judge did say, after distinguishing sale and purchase of goodwill situations, that "nevertheless the totality of the transaction between the parties must be taken into account". That plainly is correct.

  32. However, the Judge’s reasoning then excluded from his assessment all aspects of the transaction other than the acquisition by the employee of the employer’s proprietary information and trade secrets during the course of the employment. He reached that position by reference to the anticipated intellectual property right protection. That led to the case being treated as involving a straightforward employer/employee situation as in the Gallagher case: "a mid-level manager with knowledge of confidential product, sales and marketing information".

  33. The purpose of the covenant, so far as it protected the company’s investment in the acquisition and commercial development of the designs, was regarded as being spent once "the statutory protective regimes of patent and design registration could take effect". This view rested on two assumptions; first that the purpose of those registrations is the same as the purpose of the covenant, and secondly that the protection from the registrations would be in place within two years of the commencement of the employment.

  34. The purpose of the covenant is to be ascertained as a matter of construction of the contracts. For the reasons so clearly spelt out by Lord Wilberforce in Prenn v Simmonds [1971] 3 All ER 237, 240 the negotiations of the parties and statements of subjective intentions are neither helpful nor admissible: see also Investors Compensation Scheme Ltd v West Bromwich Building Soc [1998] 1 All ER 98, 114 and Boat Park Ltd v Hutchinson [1999] 2 NZLR 74, 82. Judge Colgan in his judgment drew upon statements of the two executives of the company who had been engaged in the negotiations and formed his view of the interests of the company the covenant was to protect from what they said were their objectives. That was wrong in principle.

  35. Since it was expressly stated that the covenant was given in consideration of the company entering into the sale and purchase agreement, it is from that agreement (which, of course, encompassed the employment contract) that the purpose of the covenant is to be discerned. We do not consider we are precluded by s 135(1) from interpreting that. The position is plain enough in any event.

  36. The company was, under the agreement, acquiring the designs for new products with the intention of undertaking the completion of design work, commercial production, the conversion of existing franchisees and promotion of the new products to potential new franchisees, all with the involvement of Mr. O’Sullivan. The parties undoubtedly would have recognised the major investment of resources to be made by the company (in addition to the $1.7 m acquisition price) and the long-term commitment in business strategy involved. To protect that, the company wanted the creator of the designs and the person to be given responsibility for the critical relations with franchised fabricators of the new products to be restrained from working for a competitor or from soliciting customers etc for a period of two years after leaving the company’s employment.

  37. We see no reason why a company should not be entitled to take a covenant to protect these interests. They are no less legitimate than the capital investment in a joint venture to which the Dawnay Day & Co case related. They are analogous to goodwill. The intangible designs and the involvement of Mr. O’Sullivan in their development and exploitation were acquired for the purpose of establishing (in effect) a whole new business the retention of which could be undermined by competitive involvement of Mr. O’Sullivan. Such an involvement by the person responsible for the design and marketing of the products would derogate from that which the company was acquiring. A sale of the means to establish a business and goodwill to which the vendor is to be a vital contributor is not easily distinguished in the context from the sale of an established goodwill. The need for protection is no different.

  38. The purpose of registering designs and patents (though the contractual obligation was to make only "at least one application for registration of a design") is to protect against infringement. The scope of that protection will depend on a number of factors including the degree of innovation, but whatever the scope, the protection is against infringement not competition. They may be very different things. In a field in which there are many existing registrations the degree of novelty in each additional configuration might be quite small. The scope of the protection will be correspondingly narrow. Competition will be possible so long as that narrow area of protection is avoided. That form of competition cannot be restrained as infringement of the registration, but it is the focus of the covenant against competition in the same industry. Accordingly, the purposes of the covenant and of the design registrations are quite different.

  39. That raises the question whether, as a matter of public interest, it should be possible to restrain, by covenant on the vendor of intellectual property rights, conduct beyond the scope accorded those rights under the law. We see no reason in principle why it should not be possible. The restraint is against only the vendor. Others may compete outside the scope of the statutory protections. The restraint on that one person as vendor, so long as it is reasonable, simply permits the purchaser full enjoyment of that which has been purchased — the opportunity to commercially exploit the rights free from competition from the vendor. That is no different from where no intellectual property rights are involved as eg in the Dawnay, Day & Co case. From a public interest perspective to decline to allow restraint in such circumstances might deter those with the necessary capital and expertise from acquiring new inventions and designs from those lacking the resources to undertake commercial exploitation because of concern that the vendor might provide a competitor with competing technology. In any event, in this case the transaction as a whole involved much more than simply the sale of a protected right. The vendor was to be intimately involved in the on-going technical and commercial development of the designs.

  40. The second assumption seemingly made by the Judge was that all registered protection would be in place within two years. That is not what the evidence of the company’s patent attorney, Mr. Jones, said. His evidence was of deferring as long as possible publication of complete specifications on patent applications for the purpose of delaying disclosure to potential competitors. The grant of registration and the entitlement to sue for infringement may not eventuate for some time — see Pacific Coilcoaters Ltd v Interpress Associates Ltd [1998] 2 NZLR 19. Even if the registration of intellectual property rights were to be taken as providing the same protection as the covenant, it is not correct to proceed on the assumption that the protection would have been expected to be in place within two years. But, in any event, for the reasons given, the protection is not the same.

  41. It follows from what we have said that by confining his assessment of the reasonableness of the covenant to the position of Mr. O’Sullivan as employee and regarding protection of the company as purchaser as having been met by the intellectual property protection to be sought, the Judge erred in principle.

  42. The applicable principles were reviewed in the decision of this Court in Brown v Brown [1980] 1 NZLR 484. That case involved the acquisition by one shareholder of the shares of his brother in a company with an established welldrilling business. A covenant restraining the seller from competing with the company, (modified as to area by the lower Court) was upheld, though the duration was modified from 20 years to 12 years. What is clear from the judgments in that case is that it is no answer to a complaint of the unreasonableness of a covenant that it was agreed to by the covenantor, particularly in circumstances of imbalance in bargaining strength. But in commercial transactions involving willing vendor and willing purchaser of equal bargaining power and access to advice there is a reluctance to intervene by holding one term of the overall arrangement to be unreasonable. It is impossible to assess what a purchaser might have been prepared to pay if the restraint had not been included.

  43. In Brown v Brown McMullin J (p 502) said:

    It was argued on behalf of the respondents that the Court should not lightly interfere with the terms of a bargain which the parties had hammered out for themselves. The submission is one of some importance because, inevitably in any commercial transaction, the consideration moving from one party must be measured against that moving from the other and one party’s willingness to make concessions may well depend on the benefits which he receives in return. It is not possible to say what the first respondent would have paid to the appellant if the latter had not been willing to give a 20 year covenant. The point has legal efficacy as well as practical importance because the freedom of a party to make his own bargain is well recognised. Two statements of high authority are worth repeating. Lord Shaw of Dunfermline in Herbert Morris Ltd v Saxelby [1916] 1 AC 688, 713 said:

    When a business is sold, the vendor, who, it may be, has inherited it or built it up, seeks to realize this piece of property, and obtains a purchaser upon a condition without which the whole transaction would be valueless. He sells, he himself agreeing not to compete; and the law upholds such a bargain, and declines to permit a vendor to derogate from his own grant. Public interest cannot be invoked to render such a bargain nugatory: to do so would be to use public interest for the destruction of property.

    Lord Morris of Borth-y-Gest in Esso Petroleum Co Ltd v Garage (Stourport) Ltd [1968] AC 269, 304-305; [1967] 1 All ER 699, 711-712 said:

    The law lends its weight to uphold and enforce contracts freely entered into. The law does not allow a man to derogate from his grant. If someone has sold the goodwill of his business, some restraint to enable the purchaser to have that which he has bought may be recognised as reasonable. Some restraints to ensure the protection of confidential information may be similarly regarded. The law recognises that if business contracts are fairly made by parties who are on equal terms such parties should know their business best. If there has been no irregularity, the law does not mend or amend contracts merely for the relief of those for whom things have not turned out well.

  44. Similarly in Allied Dunbar (Frank Weisinger) Ltd v Weisinger [1988] IRLR 60, 65 (para 32) Millett J said:

    It is also, in my judgment, a dangerous doctrine, since it calls upon the court to perform a balancing exercise which is not in reality capable of being carried out and which is best left to the parties to resolve by the process of negotiations. Take the present case: the restraint imposed on the defendant is severe in extent, but relatively short in duration. He is, in effect, required to take a two-year sabbatical. For a man of 52, who has been earning nearly £200,000 a year and who has received nearly £400,000 for the sale of his business, that is hardly a terrifying prospect. Some would find it positively attractive. But let it be assumed to be a detriment. How is it to be weighed against the protection sought by the plaintiffs? The truth is that there is no objective standard by which this can be done. It must be resolved by negotiation. If the advantage to the covenantee of the added protection of a more stringent covenant is perceived by the covenantee to be slight, he will offer little for it. If, by contrast, the detriment to the covenantor of such a covenant is perceived by the covenantor to be great, he will demand a high price for it. If the parties are to reach agreement, something must give, either in the terms of the covenant or in the price. Just as the parties are the best judges of the reasonableness as between themselves of the terms they have negotiated, so the price is the best means of adjusting the otherwise disproportionate advantages and disadvantages of the other terms of the contract.

  45. This was a composite arrangement. The company sought the protection of the restraint on Mr. O’Sullivan for two years. It was paying a substantial sum at the outset with ongoing payments provided for, it was committing to heavy investment in product and market development, that would involve being committed to and bound into the market for those designs in the long term, and Mr. O’Sullivan was to have the role of developing and retaining relationships with contracted fabricators so that he would have full knowledge of the inner and outer workings of the company’s business. The covenant was negotiated by the parties at arms length and on equal terms, the negotiations were extensive and were conducted with the assistance of legal advice. It was a term in an overall commercial arrangement having a large element of sale and purchase of property intended to become the key element in the company’s business.

  46. The Judge adopted in his modification of the covenant a diminishing period. That was because he saw the company’s need for protection of the property rights purchased diminishing whereas the duration of the covenant remained unchanged and ran not from the purchase of the property rights, but from termination of the employment. In some circumstances that might be unreasonable, but two factors lead us to the view that that is not this case. Not only was the company purchasing the designs which it would need to develop and bring to commercial exploitation for which the sum of $1.7 m was paid, but it was also to continue to pay, during the period of the employment of Mr. O’Sullivan, commission on sales of the products to new fabricators and it would be his role to persuade of the merits of converting to the designs. The Judge did not take account of the need for increasing protection for the company as Mr. O’Sullivan’s relationship with the fabricators in association with the products increased. That client connection (goodwill) was also being acquired by the company.

  47. We are satisfied that if the Judge had approached the matter guided by the principles we have set out, he would have concluded that the duration of the covenant is not unreasonable.

  48. We allow the appeal and substitute for the order made by the Judge an order reinstating the terms of operation of the covenant so that it is modified only by the deletion of the reference to "suppliers".

  49. The appellant is entitled to costs in this Court and in the Employment Court. Costs in the Employment Court should be fixed by that Court in light of this judgment. In this Court costs are fixed at $5,000 together with disbursements including the reasonable travel and accommodation expenses of counsel as approved (if necessary) by the Registrar.


Cases

Gallagher Group Ltd v Walley [1999] 1 ERNZ 490; Air NZ Ltd v Johnson [1992] 1 ERNZ 700; A-G v NZ PPTA [1992] 1 ERNZ 1163; Nordenfelt v Maxim Nordenfelt Guns and Ammunition Co [1894] AC 535; Herbert Morris Ltd v Saxelby [1916] AC 688; Dawnay, Day & Co Ltd v D’Alphen [1998] ICR 1068; Prenn v Simmonds [1971] 3 All ER 237; Investors Compensation Scheme Ltd v West Bromwich Building Soc [1998] 1 All ER 98; Boat Park Ltd v Hutchinson [1999] 2 NZLR 74; Pacific Coilcoaters Ltd v Interpress Associates Ltd [1998] 2 NZLR 19; Brown v Brown [1980] 1 NZLR 484; Allied Dunbar (Frank Weisinger) Ltd v Weisinger [1988] IRLR 60

Legislations

Illegal Contracts Act 1970, s.8

Employment Contracts Act, s.135

Representations

J G Miles QC and C M Meechan for Appellant (instructed by Bell Gully, Auckland).
D J Neutze for Respondent (instructed by Brookfields, Auckland)


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