Thursday, January 30, 2014

Restrictive Covenants - Unbreakable Shackle or Unenforceable Nuisance?


The start of one's employment relationship is akin to the honeymoon period of a marriage. However, when things go sour, the resulting "divorce" can become acrimonious. For employees, the dissolution of the employment relationship is especially difficult if an employer relies upon restrictive covenants in the employment contract that restrict the employee's future employment prospects.

What are Restrictive Covenants?

Restrictive covenants in the employment context can generally be divided into the following two categories:

  • Non-Solicitation Clauses: A clause in an employment contract that prohibits a departing employee from soliciting customer of his/her former employer.
  • Non-Compete Clauses: A clause in an employment contract that attempts to keep former employees out of a business. These types of clauses are generally unenforceable on public policy grounds as courts have generally found that the society has an interest in every individual carrying his/her trade freely. Courts generally do not enforce a non-compete clause if non-solicitation clauses adequately protect the employer's interest.
Unlike other commercial contracts, courts are cognizant of the special nature of an employment contract. 

On the one hand, an employer may have a legitimate interest in protecting it's trade secrets, confidential information and trade connections. On the other hand, the imbalance of bargaining power between an employer and employee may lead to the inclusion of a restraint of trade which was not negotiated "freely." 

Accordingly, blanket restraints on freedom to compete are generally held unenforceable in Canada. Non-solicitation agreements, which preclude contact with and solicitation of the former employer's customers, are more likely to be upheld, however,if they are reasonable in scope and duration.

In Elsley v. J.G. Collins Ins. Agencies, the Supreme Court of Canada articulated the following four-part test to determine whether a post-employment contractual restraint could be enforced:

  1. Does the employer have a proprietary interest entitled to protection?
  2. Are the temporal and geographical restrictions too broad?
  3. Are the terms of the restraint clear, certain and unambiguous?
  4. Is the restraint reasonable in terms of public interest?
A Contract within a Contract

Restrictive covenants will be more rigidly enforced if the context is a commercial agreement.  They are somewhat less likely to be enforceable if the relationship between the parties is one of employer-employee. 

However, what if the contract governing the employment relationship is set out in a commercial contract for the sale of assets? Although Canadian jurisprudence on the topic of "restraint of trade" is extensive, the Supreme Court of Canada's decision in Payette v. Guay Inc. last year provides clarity on the enforceability of a "restrictive covenant linked to a commercial agreement from the scope of one linked to a contract of employment (Payette,, para 5)."

Such was the problem associated with Mr. Yannick Payette's employment. Upon selling his crane rental business to Guay Inc. and in an effort to "ensure a smooth transition in operations following the sale" (Payette, para 12), Mr. Payette was employed as a consultant for a six month period. The agreement of sale provided that Mr. Payette was bound by a non-competition and non-solicitation clause. At the end of the six month transitional period, the parties agreed on a new "contract of employment for a fixed term that was optional and separate ...[that was further] renewed beyond that date for an indeterminate term (Payette, para 13)."

At the termination of his employment, Mr. Payette began a new job as a operations manager at company that was a direct competitor of his former employer. Legal proceedings were commenced with Guay Inc. alleging Mr. Payette breached the restrictive covenant embedded in the commercial agreement, while Mr. Payette argued the restraint of trade imposed by his former employer was unreasonable and unenforceable.

Freedom of Contract versus Freedom to Contract

In rejecting Mr. Payette's argument, the Supreme Court of Canada held that the restrictive covenant in this case was made in a commercial context and was lawfully enforceable. The mere fact that these clauses appeared in a hybrid agreement did not "negate the foundations and rationale" for their inclusion in the commercial contract - being the protection of the assets acquired by Guay Inc. Accordingly, the primary purpose of these covenants was to govern the sale of business rather than govern Mr. Payette's post-sale service as a consultant.

Here are a list of factors the Court considered in coming to this conclusion:
  • Wording of the Contract: "actual language of the parties' agreement confirms that the existence of the restrictive covenants is closely related to the conditions for the sale of the assets, which were negotiated and accepted by the appellant Payette as a 'vendor', not as an 'employee' (Payette, para 47)."
  • Context of the Agreement: "the main point of the sale transaction for the respondent was to acquire the vendors' goodwill, skilled employees and customers. If the respondent had not obtained the protection in question, the transaction would never have taken place (Payette, para 49)."
  • Lack of Power Imbalance: "the October 2004 agreement, which had a substantial value of $26 million, was entered into following lengthy negotiations between well-informed businesspeople who were on equal terms and were being advised by legal and accounting professionals (Payette, para 62)."
If you have executed (or are being asked to execute) a non-competition or non-solicitation agreement, obtain legal advice before acting.  The consequences of breaching a valid restrictive covenant can be very significant in terms of damages awards.  These are employment documents that should never be simply disregarded.
- Nitin Pardal, Toronto
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