Non-competition agreements

In the 1930s, Bette Davis entered into a contract with Warner Brothers Pictures Inc. under which she promised to “render her exclusive services as a motion picture and/or legitimate stage actress” to Warner. Much to her later chagrin, the actress also agreed not to render any services to any other person without Warner’s prior written consent. The contract also stated that if Davis refused or neglected to perform services for Warner, the company could extend her contract and all of its provisions for as long as she continued to refuse. The practical effect of this provision was to bind Davis to Warner Brothers for the rest of her life.

When she eventually declined to be bound by her agreement with Warner and left America to work in the U.K., that’s when the fireworks really started. A British court eventually reached a “compromise” shortening the duration of the restrictions.

The use of non-competition agreements in employment relationships was controversial long before Davis and Warner Brothers butted heads, and they remain controversial to this day. Nonetheless, they remain widely used. They are common in industries such as health services, where dentists or doctors who practice together often sign agreements restricting where they can practice when their association ends.

Similarly, sales employees are often required to sign non-competition agreements preventing them from leaving and taking their client contacts with them. Most recently, we have seen the widespread use of these agreements in the high-tech sector, where everyone from chief executive officers down to low-level programmers are subject to restrictive covenants which attempt to curb their competitive activities when their employment ends.

One would think that because of their common use, non-competition agreements are uncontroversial and legally justifiable. This is not the case.

In fact, the general rule in most common-law jurisdictions (including Canada) is that non-competition clauses in employment contracts are void. This general rule, and the rationale for it, were succinctly stated in an 1894 English House of Lords case, Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co. Ltd. ([1894] AC 535 at 565): “The public have an interest in every person carrying on his trade freely; so has the individual. All interference with individual liberty of action in trading, and all restraints of trade themselves, if there is nothing more, are contrary to public policy, and therefore void. That is the general rule.”

Thankfully for most employers, this general rule does have a few exceptions. In Nordenfelt, the court went on to state that restraints of trade may be held to be valid where the restraint is both “reasonable in the interests of the contracting parties” and “reasonable in the public interest.”

In 1978, the Supreme Court of Canada explored these exceptions in Elsley v. G. J. Collins Insurance Agencies Ltd. ([1978] 2 SCR 916). In Elsley, the court stated that non-competition agreements (which are a form of “restrictive covenant”) bring into stark relief a conflict between two long-standing principles: first, discouraging restraints on trade, and second, respecting freedom of contract.

The court stated: “The principles to be applied in considering restrictive covenants of employment are well established…a covenant in restraint of trade is enforceable only if it is reasonable between the parties and with reference to the public interest. As in many of the cases which come before the courts, competing demands must be weighed. There is an important public interest in discouraging restraints on trade, and maintaining free and open competition unencumbered by the fetters of restrictive covenants. On the other hand, the courts have been disinclined to restrict the right to contract, particularly when that right has been exercised by knowledgeable persons of equal bargaining power.”

To reconcile these two competing interests, courts will assess the “reasonableness” of the agreement. The court also set out three factors which it stated require special attention when considering the validity of a restrictive covenant:

•whether the employer has a proprietary interest entitled to protection;

•whether the temporal or spatial features (duration and geography) of the clause are too broad; and

•whether the covenant is unenforceable as being against competition generally, and not limited to prescribing solicitation of clients of the former employee.

Practically speaking, employers will have a “proprietary interest” in, for example, their client base or client lists. They will also have a proprietary interest in their intellectual property, such as their patents, trademarks and special or unique designs or methods.

When considering the reasonableness of a restrictive covenant’s duration, courts will be eager to ensure that an employer’s interests are indeed protected, but not for so long that the employee is prevented from making a living. In practice, courts will often examine if the non-competition agreement is close in length to the period of reasonable notice or severance package provided to the employee. With respect to the geographic features of the clause, a relevant factor will be the employer’s market. If the employer operates only on the West Coast, a non-competition agreement preventing the employee from working anywhere in North America will likely be invalid.

On the third factor, the court will consider whether a prohibition against a former employee’s solicitation of clients would be sufficient to protect the employer’s interests, and whether the employer has overstepped the bounds of legality by imposing a more stringent prohibition against competition generally.

Broadly speaking, the courts will be far more ready to enforce a clause preventing an ex-employee from soliciting clients as opposed to a full-blown non-competition clause.

The implications of having a non-competition agreement in place which a court considers to be too broad are quite serious. The court will not re-write a non-competition agreement it finds too broad. Rather, it will strike it out in its entirety. In practice this means an ex-employee will have no restrictions on competitive activities. As a result, it is important for employers to be careful in crafting non-competition provisions or they could find themselves without any protection at all.

There are a number of things an employer should keep in mind when considering using a non-competition agreement:

•Be sure your company needs to use a non-competition agreement. With clerical employees or employees who do not stand to damage your business if they go to work with a competitor, non-competition agreements should likely not be used.

•Consider using a non-solicitation agreement as opposed to a non-competition agreement. Generally, the courts will be more likely to enforce a non-solicitation agreement as opposed to a non-competition agreement. Consider what activities of former employees you wish to restrict. If the real worry is them soliciting current customers, then a non-solicitation agreement is likely sufficient.

•Draft the time and geographic limitations in the non-competition agreement as narrowly as possible. Geographic limitations should generally not expand outside the market in which your business directly competes. Make the duration of the restrictions as short as necessary. Use the length of the period of notice or severance package as a guide.

Picking up where we left off our poor Bette Davis, when she entered into an agreement with a new company in the U.K., Warner commenced an action for breach of contract and sought an injunction to restrain Davis from acting in breach of the agreement. Davis argued the restrictions on her were illegal as they were a restraint of trade.

In a display of judicial baby-splitting, the Kings Bench granted an injunction forcing. Davis to act out her contract with Warner for the shorter of three years or the continuation of the contract. According to the court, Davis was “a person of intelligence, capacity and means,” and they drew comfort in their decision from the assumption that her talents were such that, although her career might be compromised by the injunction, the damage would not be reparable and she would not remain idle for long. It is not likely that a court in Canada today would come to the same conclusion.

Lucas Corwin was recently a lawyer with the labour, employment and human rights department of Fasken Martineau DuMoulin LLP in Vancouver. He is now a lawyer with the Public Sector Employer’s Council of British Columbia.

Latest stories