New Guidelines for Restrictive Covenants in Canada


Amy Knapp

Implications of recent decision
Martin v. ConCreate USL Limited Partnership

Restrictive
covenants are a tricky business. While
fundamentally important in some circumstances, they’re notoriously ineffective
in others. With the recent rulings on enforcement of restrictive covenants, it's becoming even more apparent that Canadian companies need to develop more compelling strategies to keep talent from going to the competitors.

The term “restrictive covenant” may refer to either a
non-competition agreement, which forbids an employee from working with a
competitor for a period of time after termination of employment, or a
non-solicitation agreement, which
forbids an employee from soliciting former clients for competitive purposes.

The Canadian courts have set the bar high on restrictive
covenants. They are considered prima
facie
unenforceable as they constitute a restraint of trade and infringe on
individual liberty. For those of you who don’t speak legalese, prima facie means the matter is
considered to be self-evident. Guilty until proven innocent.

This point was driven home by last year’s decision Mason v. Chem-Trend Limited, and again this month in Martin v. ConCreate USL Limited Partnership. The case law agrees these
covenants are only enforceable in certain—very specific—situations.

The more recent case is considered especially significant since
the restrictive covenants in Martin
were in the context of a sale of business. In this context it is often necessary
to protect goodwill: Restrictive covenants are therefore subjected to a less
rigorous test by the courts when compared with similar covenants in standard
employment contracts.

And yet Martin won his appeal. While the judge agreed
restrictive covenants are important in a sale of business, he concluded the
non-competition agreements in Martin’s case were overly broad. In such cases, the Canadian
courts will not “read down” the covenant to better suit the circumstances. It
will either be upheld or struck down in its entirety. 

The Simple Facts:

Martin works for Company X, in which he owns a small stake
along with its sister company, Company Y. Both companies are sold to Company Z
and their assets sold to one of its entities. (Still with me? We’ll break this
down nice and easy.)

Since Martin retained 25% of the limited partnership units in
Company Z, as part of the sale he was required to sign a non-competition and
non-solicitation agreement relating to use of confidential information, which
would end 24 months after Martin disposed of the units in question.

Six months after the sale Martin was terminated. Eight days
later he started a competing business. Companies X and Y sued and won. Martin
appealed seeking the covenants to be declared ambiguous and unreasonable and
therefore unenforceable, which they were last week by the Ontario Court of
Appeals. 

The Court considered three things.

  • Geographic scope
    of the limitation:
    The geographic scope was not considered problematic.
    Being a national company, in made sense that the restriction would apply
    nationally. 
  • Extent of
    prohibited activity:
    Martin’s contract included a non-solicitation
    agreement that barred him from dealing with “any products or services that
    compete with products or services offered by [Company X/Y], whether or not
    offered, or planned to be offered, […] at the time of the sale transaction
    .”
    Given the vague nature of this limitation, the scope of prohibited activity was
    considered too broad.
  • Duration of
    limitation:
    Since the duration was calculated from a time that hinged on
    the consent of a third party (the disposition of his partnership units), the
    court concluded that there was no fixed limit on the restriction. Had it been
    calculated from the time of the sale of business or from the time Martin ceased
    acting as an officer or director of Company Y/Z, it may have been decided
    otherwise.

Even when a contract is concluded between knowledgeable parties
of equal bargaining power, it must still pass the test of reasonable duration,
activity and geographic scope. Though Martin had legal counsel when negotiating
these agreements and acknowledged their reasonableness, the judge concluded
that, “while these are
important factors, they do not entirely immunize the clause from
scrutiny,"

Key Points of the
Decision:

There are a
few key things we can take away from this decision, which further enforced last
year’s decision on Mason v. Chem-Trend.

  • A fixed time limit is essential.
  • Restrictive covenants are looked
    at on a case by case analysis of their reasonableness. 
  • Overly broad restrictions will be
    deemed unenforceable. 

Note that
there may be more room for broader non-competition agreements imposed on
employees of senior rank, especially those in executive positions.

While this sort of protection may be necessary in some
situations, restrictive covenants are not generally looked on favourably by the
Canadian courts. An employer that seeks to protect himself by including
non-competition or non-solicitation agreements would do well to use them
sparingly, or else risk jeopardizing the effectiveness of the agreement.

A more reliable alternative might be to look at employee
retention
, to ensure employees are not only paid market rates but also offered
performance-based compensation. An employee who feels valued by his employer is
not an employee likely to be seduced by the competition.

If the staff are happy, restrictive covenants are essentially a
moot point.

Amy Knapp writes about audacious
and unconventional career management tactics for
Australian job search site InsideTrak. She holds a BFA from Concordia University and also
completed three misguided years at law school. Her travel memoir,
I Am The Swallow, will be published this Spring by Iguana Books. She lives in Ontario, Canada.


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