Friday, November 19, 2010

Ontario Employment Law: Restrictive Covenants 101

Employers often wish to protect their commercial and business interests by contractually limiting the ability of departing employees to use confidential information, compete with the employer, and solicit the employer's customers and staff in the period subsequent to employment.

The employment contracts that set out these limitations are known as restrictive covenants. We will be canvas these provisions in detail in a series of posts over the weeks ahead.

In this introduction, we will provide basic definitions and a general overview of the issues that typically arise in connection with restrictive covenants in employment agreements.

Definitions:

There are three major types of restrictive covenants that may typically be found in some Canadian employment contracts.
  • Confidentiality agreements prohibit employees from disclosing the confidential information of the employer during and subsequent to employment, unless authorized. A typical confidentiality agreement will define the specific categories of information that are to be protected, require the employee's undertaking of non-disclosure of such information, and detail the specific, adverse legal consequences facing an employee who fails to maintain such confidentiality.
  • Non-solicitation agreements typically prohibit a departing employee from directly or indirectly soliciting the employer's clients, prospective clients and employees for a specified time period following termination of employment.
  • Non-competition agreements have a wider ambit than non-solicitation agreements - they purport to wholly restrict competition by the employee in related commercial endeavours. Such agreements typically prohibit former employees from working for direct competitors or from directly or indirectly competing with the employer's core businesses after termination. These agreements generally apply for a specified time frame, provide extended definitions of the prohibited businesses, and define the geographical regions within which such competition is prohibited.
Enforceability of Restrictive Covenants in Ontario Courts

As a general rule, for these covenants to be enforced by courts they must entirely clear, be reasonable in scope and meet fairly rigorous tests of such reasonableness.

For example, the employer must show that the restrictions set out are no more than is necessary to protect the legitimate business interest at stake. The departing employee’s freedom of contract must be not be unduly restricted and excessive restraint of trade is not permitted, particularly if no legitimate commercial interest of the employer is protected by an impugned covenant.

As a result, where these covenants overreach by having unreasonably extended scope, they are vulnerable to being unenforceable by the courts.

There are numerous recent examples of cases where the courts have declined to enforce these covenants, not least of which is the Ontario Court of Appeal's 2008 ruling in H. L. Staebler Company Limited v. Tim James Allan, et al., an important decision that reaffirms the limited enforceability of non-competition covenants in Canadian employment agreements.

As similar outcome emerged from the January, 2009 ruling of the Supreme Court of Canada in Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6 (CanLII). In Shafron, the Supreme Court of Canada overturned a ruling of the British Columbia Court of Appeal that had liberally interpreted and enforced a non-competition covenant that purported to restrict a former employee's ability to work in the Greater Vancouver area. The Supreme Court of Canada held the employer to the strict wording of the covenant, which referred to the non-existent entity of the "Metropolitan City of Vancouver," and refused to enforce the covenant.

Obtain Legal Advice Before Signing

Employees who are asked to sign such agreements are strongly advised to obtain legal advice from a qualified employment lawyer before signing any documentation. While this is, of course, true of all employment contracts, it is particularly the case with respect to the restrictive covenants discussed in this introduction.

Where enforceable, these agreements can lead to highly adverse consequences for former employees upon termination, including potentially protracted financial losses.

They may limit re-employability following a termination; in some cases, new employers have been held liable for the roles they have taken in inducing breaches of restrictive covenants. Further, it is important to note that these restrictive covenants may be enforceable, even in circumstances where an employee is terminated without cause after a short period of employment.

Thus, we'll close this introductory discussion by underlining that these agreements are serious legal documents that ought not to be taken lightly by employers or employees alike.

In future posts, we'll take a closer look at the courts' treatment of these restrictive covenants in specific employment contexts.
- Garry J. Wise and Robert Tanha, Toronto

Visit our Toronto Law Firm website: www.wiselaw.net

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