'The more narrow the restrictions, the better off you'll be,' says employment lawyer
An Alberta court has dismissed claims brought by an employer against three former independent contractors and their respective corporations for breaching restrictive covenants, which the court found to be unenforceable.
The court essentially determined that, in most cases, the analysis of whether restrictive covenants are enforceable with independent contractors is going to be the same as it is for employees, according to Roxanne Davis, an employment and human rights lawyer at Carbert Waite in Calgary.
“If you can show that the independent contractor has more bargaining power than an employee typically does in the particular circumstances or that they were given additional value for agreeing to the terms of the restrictive covenant, then this decision might have gone differently, but that wasn't the case with these individuals,” says Davis.
NL Fisher is an engineering firm specializing in drilling supervision and design services in Western Canada. The company assigns employees and subcontractors to design and supervise drilling projects for clients.
The three workers provided well-site drilling supervision services as independent contractors through their respective corporations starting in late 2016 and early 2017. Their corporations issued invoices to NL Fisher for their services and the company paid their corporations.
Restrictive covenants
NL Fisher didn’t have written consulting contracts with the three workers, but it required them to sign confidentiality agreements. These agreements included a clause banning the workers from directly or indirectly working with the company’s clients in any capacity for six months after the termination of their contracts. The clause specified that the ban applied to any “entity or individual that has been a client of NL Fisher’s at any time during the two-year period prior to the date of termination.”
In 2018, the company modified the confidentiality agreements, increasing the period during which they couldn’t work for NL Fisher clients from six months to two years after termination.
The new agreements also incorporated a “conversion clause,” which included a table of compensation that the workers would have to pay NL Fisher in the event of a breach “of the term.” The clause described the conversion fee as a “percentage of total actual invoiced amount” that decreased over the duration of the assignment from the date of the agreement.
Initially, NL Fisher provided work by calling the workers to discuss the client site, compensation terms, and services required. In 2019, it sent them purchase orders electronically and, for each assignment, the workers had to check a box indicating that they had read and agreed to the terms of the confidentiality agreement to accept a purchase order.
In early September 2022, all three workers and their corporations stopped working for NL Fisher and invoiced the company for services they had recently performed for the company’s client, Deltastream Energy Corporation.
Employer alleged breach of non-compete agreement
The three workers and their corporations began working with another company almost immediately, which contracted their corporations to perform work for Deltastream. The services they provided to Deltastream were the same they had provided through NL Fisher.
NL Fisher alleged that this arrangement violated the confidentiality agreements and sued for damages equal to the conversion fees for breaches. The workers counterclaimed for unpaid invoices from their last assignment for NL Fisher, arguing that the confidentiality agreements were unenforceable. The company argued the unpaid invoices were subject to set-off because of the alleged breaches.
The court referred to the Supreme Court of Canada’s description of restrictive covenants as a “restraint of trade” in common law and, in general, “all restraints of trade were contrary to public policy and therefore void.” However, the top court noted that there could be an exception if the restraint of trade was reasonable.
NL Fisher maintained that the agreements weren’t traditional non-competition agreements or restraints of trade because the workers were independent contractors and not in an employment situation, and they were free to work for anyone except for its clients. It also argued that the workers could work for its clients as well if they paid the conversion fee.
Restrictions too broad
The court found the clause prohibiting the workers from working with NL Fisher clients overly broad and unreasonable. It applied to any client of NL Fisher in the two years preceding termination, regardless of whether the subcontractors had worked with or were aware of those clients. Such sweeping restrictions weren’t justifiable and failed to balance NL Fisher's proprietary interests with the subcontractors' rights to work, said the court.
“One thing the court latched on to is something that we recommend, which is make it specific to the clients that the individual had a relationship with and not so broad that it prevents the departing employee or contractor from working with any client that the company ever had, including ones they never had any contact with,” says Davis. “That's another typical reason for striking down the enforceability of a restrictive covenant, along with being too broad in the geographic region to which the restrictions apply – the more narrow the restrictions, the better off you’ll be.”
The court also found the two-year restriction was excessive, as the company was unable to justify why it was increased from six months in the earlier agreements to two years.
“Courts have said, generally with respect to non-compete agreements, that the time period they cover should be as short as possible to give the employer an opportunity to reach out to clients and maintain those relationships,” says Davis. “If you have an employee who's leaving and you're worried that they might try and take some business away from you, generally speaking six months is going to be enough time to reach out to all of those clients - the courts don't buy into an argument that companies will need two years to do that in most circumstances.”
As for the conversion fee provision, the court found this was ambiguous, noting that the clause didn’t clearly specify which breaches of the agreement would trigger the fee – this particular clause used the singular “term” when referring to a breach, but not which term or if it was all of them. Furthermore, key terms such as "total actual invoiced amount," were undefined, leaving room for multiple interpretations, the court said, adding that the provision didn’t specifically eliminate the restrictions if payment was made.
Ambiguous terms
It’s fairly rare for contracts to get into specifics about what the damages are going to be for breach of the restrictive covenants, says Davis.
“If you're going to put that kind of specific information in your terms, you need to be absolutely clear about what type of breach it applies to, whether it’s poaching employees or poaching clients, and make it explicitly clear of how it's calculated,” she says. “The court found that the way [NL Fisher] drafted this clause was ambiguous in those respects - courts are going to be very much interpreting in favour of employees (in this case, independent contractors), if there's any way of interpreting it that makes it vague.”
The court disagreed with NL Fisher’s argument that the confidentiality agreements shouldn’t be subject to the same scrutiny as if it were an employment relationship, finding that the power imbalance was similar to if the workers were employees and not independent contactors. The agreements were standard form contracts drafted by legal counsel that NL Fisher had many consultants sign, and the workers had no ability to negotiate the terms or have any choice if they wanted to continue getting work from the company, the court said.
The court emphasized that restrictive covenants in employment or contractor agreements must be clear, unambiguous, and reasonable to be enforceable – which in this case they were not.
The court dismissed NL Fisher’s claims for damages for breach of the restrictive covenants and awarded the workers’ corporations the unpaid amounts invoiced prior to termination, totalling more than $75,000 between the three.
It can be challenging for employers to draft an enforceable restrictive covenant, but usually a non-solicitation agreement with narrow restrictions has a better chance of success, says Davis.
“If you can protect your business sufficiently with just a non-solicitation and not a non-compete agreement, then you're better off doing that - it's much more likely to be found to be enforceable,” she says. “But if you do want to include a non-compete, then don't overreach in terms of the amount of time it covers - keep it short, usually not more than six months.”
