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New Guidelines for Restrictive Covenants in Canada

Header_RestrictiveCovenantsCanada
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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