Restrictive covenants commonplace but misunderstood
Most non-competition clauses will not be enforced and non-solicitation clauses should be drafted narrowly
Sep 19, 2011
By Stuart Rudner
While non-competition and non-solicitation clauses have become commonplace, many people continue to operate under the assumption non-competition clauses will be enforced, which is generally not true. Furthermore, even those who realize non-competition clauses are unlikely to be enforced assume the non-solicitation clauses will be, regardless of the terms.
As a result, organizations rarely take the time to consider what is actually required in order to protect their interests and then draft a clause in accordance with those needs. That, of course, is what they should do in order to have the strongest chance of enforceability.
The leading Canadian case on the enforceability of non-competition clauses is the Supreme Court of Canada’s decision in Elsley v. J.G. Collins Ins. Agencies. Elsley had entered into an agreement that contained a covenant prohibiting him from engaging in the business of a general insurance agent throughout his employment and for five years following termination. Liquidated damages for breach of the covenant were fixed at $1,000. Justice Dickson outlined the test for determining whether such a covenant is enforceable: “A covenant in restraint of trade is enforceable only if it is reasonable between the parties and with reference to the public interest.”
Justice Dickson went on to explain that reasonableness is to be assessed based upon the unique circumstances of the particular case, including the nature of the business, the character of the employment, the interests of the parties and the protections they require. In deciding what is reasonable, Justice Dickson provided that the following questions should be considered:
•First, did the employer have a proprietary interest entitled to protection (e.g. trade secrets, business connections, confidential information, or good will)?
•Second, were the temporal or spatial (geographic) features of the covenant too broad?
•Finally, is the covenant unenforceable for being against competition generally and not limited to prohibiting the solicitation of clients?
In Elsley, the evidence showed that despite the fact Elsley did not solicit former clients, 200 clients followed him. As a result, the court found a non-solicitation clause would not have provided sufficient protection.
Two recent cases have addressed restrictive covenants. The first was the decision of the Ontario Superior Court in Mason v. Chem-Trend Limited Partnership, and the most recent was the decision of the Alberta Court of Appeal in Globex Foreign Exchange Corp. v. Kelcher.
In Mason v. Chem-Trend Limited Partnership, Tom Mason, a technical sales representative, was dismissed after 17 years of service and brought an action for wrongful dismissal. Chem-Trend counterclaimed, seeking damages for breach of, among other things, a restrictive covenant which provided as follows:
I agree that if my employment is terminated for any reason by me or by the Company, I will not, for a period of one year following the termination, directly or indirectly, for my own account or as an employee or agent of any business entity, engage in any business or activity in competition with the Company by providing services or products to, or soliciting business from, any business entity which was a customer of the Company during the period in which I was an employee of the Company, or take any action that will cause the termination of the business relationship between the Company and any customer, or solicit for employment any person employed by the Company.
In Mason, the court found the clause’s extensive geographic scope was warranted and reasonable:
I accept the position of Chem-Trend that given the global nature of Chem-Trend's business, notwithstanding the limits within which Mr. Mason worked, the covenant in the circumstances of this case is not unreasonable as on the evidence before me there may have been some overlap. Mr. Mason also admitted that when he accepted employment with Chem-Trend, he could transfer from one territory to another over the course of his employment. This did happen during his career as he worked both in Canada and the United States and within various regions, making the request for a global nature of the covenant reasonable.
Furthermore, the covenant’s broad restrictions on Mason’s activities were deemed to be justified by the global nature of the business. As the court stated:
This is not a case where a non-compete has been used where a non-solicit would do. As was submitted by Chem-Trend, the reason for this restriction is that, as a technical sales representative, Mr. Mason had access to significant information about Chem-Trend's products, operations, customers and pricing that could be used against Chem-Trend and be harmful to its business. Mr. Mason had a presence in both Canada and the United States for 17 years. Mr. Mason's technical knowledge of the industry makes him a threat to Chem-Trend both in terms of the customers he knew and services he provided on behalf of Chem-Trend. He would be a competitor to Chem-Trend's business itself.
Finally, the court found the one-year restriction was reasonable, given that it was considerably shorter than other restrictive covenants that courts have enforced, and thus helped counterbalance the wide geographic scope of the clause. Accordingly, the court upheld the non-competition clause.
While Mason is not a direct departure from the previous case law, the case suggests the contextual approach laid out in Elsley can allow for broader use of restrictive covenants in our “new” global economy, which has transformed the way business is carried on and rendered geography and time less important. We may see more cases in which non-competition clauses are enforced, even if the scope of their restrictions is broader than those traditionally used.
The opposite conclusion was reached in the Alberta decision. In that case, the clause in question provided as follows:
That for a period of twelve (12) months from the date of termination of the Employee's employment with Globex, for whatever reason, he/she will not, for any reason directly of indirectly as principal, agent, owner, partner, employee, consultant, advisor, shareholder, director or officer or otherwise howsoever, own, operate, be engaged in or connected with or interested in, the operation of or in any way guarantee the debts or obligations of, or have any financial interest in or advance, lend money to, or permit his/her name or any part thereof to be used, or employed in any operation whether a proprietorship, partnership, joint venture, corporation, or other entity, or otherwise carry on, engage in, solicit customers in any manner whosoever, in any business or activity for any client of Globex with which he/she had dealings on behalf of Globex at any time within the twelve (12) months preceding the date upon which the Employee left the employment of Globex.
The majority ruled that the clause signed by the employees in question, either at the beginning of their employment or during the course thereof, was not enforceable because it was both ambiguous and overly broad.
The court went on to consider two other issues raised by the facts of this case. First, the court found continued employment does not, in and of itself, amounts to consideration for the purposes of creating a binding agreement. In other words, advising employees they have to sign the agreement or they will be fired will not result in a binding agreement.
The second point may be more controversial. The court found an employee who is wrongfully dismissed is not required to abide by a restrictive covenant that would otherwise be enforceable. Simply put, according to the court in this case, if an employer wrongfully dismisses one of its employees, it cannot rely upon a non-competition or non-solicitation clause that the employee had signed.
The two decisions referenced above are indicative of the uncertainties involved in the enforcement of restrictive covenants. I always advise clients to assume non-competition covenants will be unenforceable in the vast majority of cases, and that non-solicitation covenants should be drafted as narrowly as possible in order to have the best chance of success.
Stuart Rudner is a partner with Miller Thomson LLP in Ontario, specializing in employment law. He provides clients with strategic advice regarding all aspects of the employment relationship, and represents them before courts, mediators and tribunals. He is author of You’re Fired: Just Cause for Dismissal in Canada, published by Carswell. He can be reached at (905) 415-6767 or email@example.com. You can also follow him on Twitter @CanadianHRLaw, join his Canadian Employment Law Group on LinkedIn, and connect with him on Google+.
Stuart Rudner is the founder of Rudner Law (RudnerLaw.ca
), a firm specializing in Employment Law and Mediation. He can be reached at firstname.lastname@example.org
, (416) 864-8500 or (905) 209-6999, and you can follow on Twitter @RudnerLaw.