Legal Principles Of Restraining Clauses And Piercing The Veil Of The Company In An Essay.

Restrain Clause: Validity and Applicability

Question:

Discuss about the Business Law for Computers Pty Ltd.

1. Validity of the restrain clause that is imposed by Computers Pty Ltd on Chu?
2. Whether the company established by Chu wife be considered as company framed by Chu. Can the veil of the company be pierced?
3. Can Computers Pty Ltd sue Systems Pty Ltd for solicitation of its customers?

The applicability of restrain clause and piercing of the veil of the company are the two leading principles which are required to be analyzed in order to resolve the issues.

The restrain clauses main aim was to put restriction on an employee and forbidding him to carry out few tasks which otherwise he is free to do. The restrain clause is normally imposed by an employer upon an employee. As per the clause the employer restricts an employee to trade in similar business activities in which the employer is involved in for a particular period of time or at a particular place and is rightly held in Murray v Yorkshire Fund Managers Ltd and another [1]. The restrain clause is also imposed so that the employee does not solicit the clients of the employer. The restrain clause is valid when made part of the contract and by mutual consent of the parties.[2]

The justification on the legality of the restring clause is found on the fact that when an employee is working with an employer, then, he is aware of many information’s which if leaked out to the outside world or competitors, then, it may hamper the business, image and clientage of the employer. So, in order to protect the same, the employer can rely on the restrain clause. Thus, the main reasons for the applicability of the restrain clause are:

1. To retain the confidential information of the company;
2. To retain the goodwill of the company;

• To prevent the employee to solicit the clients of the company;

1. To restrict the employee to compete with the business of the employee for particular period or at a particle place[3].
2. When there is legitimate interest of the employer involved.

The restrain clauses are find to be important and must be incorporated so that an employer can protect his business which he has nurtured with lodes of hard work and pain. But, the restrain clauses must be only valid if they are for short duration of time, that is, one year or two years etc and is rightly held in Seven Network (Operations) Limited v Warburton (No 2) [4]. If the employer is relying on longer restrain clauses then he must justify the same.[5]

Now, there is yet principle that is important is the ‘piercing the separate legal entity’ of the company.

Whenever a company is formed then a company is not a real person, but, upon its incorporation a company is considered to be an artificial person. It is a person in the sense that it can hold property, file suits, pay taxes, etc and everything is carried out in its in name, but it is called artificial because the acts are not done by the company directly but with the help of its officers and employees. Mainly the company has its own separate legal personality which is distinct from its officers.[6]

Now, whenever any act or omission is undertaken by the company then the same is in the name of the company and no one else is responsible for the same except the company. This is the principle of Separate legal entity and is analyzed in Salomon v A Salomon & Co Ltd[7]. in Lee v Lee's Air Farming Ltd[8]  recognition is granted to the principle and it was held that an officers can be an employee and acts as a company director at the same time. [9]

Separate Legal Entity of the Company

But, there are situations wherein the officers carry out tasks in the name of the company but the same are for the own benefit or which are detrimental to the company. In such cases, the courts are willing to the pierce the veil of the company and hold the officers directly for such acts or omission which are carried out by them in the name of the company.

Some of the instances are when there is presence of agency, fraud, fabrication, etc in Gilford Motor Company Ltd v. Horne[10], a fraud is committed by the officer of the company. He in order to solicit the customer of his own company established a new company in the name of his wife. The new company main area of work is similar to the work of the officers company and is also soliciting its clients. The court held that the new company is established mainly to commit fraud on the company of the officer by the officer itself. The veil of the new company was pierced and the officer and the company were holding out to be same.[11]

Thus, the courts are willing to pierce the veil of the company and to disregard the principle of separate legal personality and to consider that the acts of the officers are the acts of the company and thus can hold the officers personally liable for the same.

Thus, these are the two important legal principles which are required to resolve the raised issues.

Issue 1

The restrain clause is valid that is imposed by Computers Pty Ltd on Chu.

Computers Pty Ltd has restricted Chu so that he does not compete against the company. Chu was the operations manager from past five years and is able to know most of the clients of the company. In March 2014, Chu was fifty years of age and retired and left the company.

Now, the restrain clause is considered to be valid because it will protect the confidential information of the company which is attained by Chu while working with Computers Pty Ltd. So in order to devoid Chu from leaking out such confidential information and to protect the goodwill of the company which it has attained over the years, the clause is valid. The legitimate interest of Computers Pty Ltd is protected by relying on the clause.

Also, the clause is any or two years and is only restrain Chu from dealing in same trade in New South Wales, that is, particular geographical region.

Thus, as per Seven Network (Operations) Limited v Warburton (No 2),  the duration of two years is valid in law.

Thus, the restrain clause is valid.

Issue 2

Computers Pty Ltd is dealing in a business of retail of computer software and hardware. Chu retired from the company in March. In April, his wife, established a company which deals in retailing of computer software and hardware.

Now, all the issues share capital of the Systems Pty Ltd was in the name of wife. She was the only director. Now, most of the clients of Systems Pty Ltd are solicited from Computers Pty Ltd in New South Wales. 

It is submitted that by applying  Gilford Motor Co Ltd v Horne  it is held that though the company, Systems Pty Ltd, was established in the name of the wife of Chu, but, the main acts which are carried out by the wife of Chu is as per the directions of Chu.

The Systems Pty Ltd is established mainly to defraud Computers Pty Ltd and to solicit its customers. Thus, the veil of Systems Pty Ltd. is pierced and the company established by the wife of Chu must be regarded to be framed by the Chu himself. He must be considered to be soliciting the customers of Computers Pty Ltd and dealing in retailing of computer software and hardware.

Issue 3

 Now, the company which is framed by Chu wife is not o be established by her, but, the same was considered to be the act of Chu. Also, Chu was soliciting the customers of Computers Pty Ltd and dealing in retailing of computer software and hardware. This act was strictly restricted by Computers Pty Ltd and which prohibit Cu from doing so for next two years in New South Wales.

But, Chu was carrying out such prohibited activity within New South Wales and within the span of two years. Thus, the restrain clause was violated by Chu.

So Computers Pty Ltd can sue Systems Pty Ltd for solicitation of its customers.

It is thus concluded that the restrain clause established by Computers Pty Ltd is valid. However the company which is made by Chu’s wife is not of her own but is in the shield of Chu. So, the shield was pierced and the company was considered to be carrying out the activities as per the wish of Chu.

So, by carrying out the activities in the name of Systems Pty Ltd, Chu is soliciting the clients of Computers Pty Ltd.

Thus, Computers Pty Ltd can sue Systems Pty Ltd for solicitation of its customers.

Books/Articles/Journals

Christensen, S and  Duncan,W, ‘Sale of Businesses in Australia’ (Federation Press, 2009).

Gibson, A and Fraser, D‘Business Law 2014’ (Pearson Education Australia, 2013).

Hargovan, Anil, ‘Piercing the Corporate Veil on Sham Transactions and Companies’ (2006) 24 Company and Securities Law Journal 436.

Ramsay, I and Noakes, D ‘Piercing the Corporate Veil in Australia’ (2001) 19 Company and Securities Law Journal 250.

Case laws

Gilford Motor Co Ltd v Horne [1933] Ch 935.

Lee v Lee's Air Farming Ltd (1961).

Murray v Yorkshire Fund Managers Ltd and another [1997].

Seven Network (Operations) Limited v Warburton (No 2) (2011).

Salomon v A Salomon & Co Ltd [1896] UKHL 1.

Woolworths Limited V Mark Konrad Olson (2014).

The Law Teacher, ‘The Separate Entity principle’ (2017) < https://www.lawteacher.net/free-law-essays/company-law/the-separate-entity-principle.php>