This Week At The Ontario Court of Appeal: 11-05-06

Each week Wise Law Blog reviews recent decisions from the Ontario Court of Appeal.

Mason v. Chem-Trend Limited Partnership. A separate application related to a wrongful dismissal suit, where the plaintiff (the dismissed employee) sought to challenge a restrictive covenant in his employment contract as unenforceable.

Mr. Mason, upon being hired by Chem-Trend as a technical sales representative, signed an employment contract containing a restrictive covenant preventing him from engaging 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" for one year following his termination for any reason.

The application judge stated that the covenant was not ambiguous, and that Mr. Mason understood its meaning when he signed it. The judge also stated that given Chem-Trend's worldwide scope, the worldwide scope of the restrictive covenant was therefore reasonable, as was restricting any activity by the appellant in conjunctin with Chem-Trend's competition for the same reason. The application judge also noted that the one-year restriction period was relatively short.

The Court of Appeal disagreed. The Court noted that the caselaw in this regard suggests that an unreasonable restrictive covenant can be found invalid if the overall limits of the clauses in the convenant are overly broad and prevent competition generally (as opposed to specifically competing against the employer by soliciting its customers).

In terms of Mr. Mason's employment contract, the Court observed that the restrictive convenant clause prevented Mr. Mason from working with any business entity which was a customer of Chem-Trend for the entirety of Mr. Mason's tenure with the company - over seventeen years. The Court held that a prohibition from working with all companies that had been customers of the business for nearly two decades was excessive; they also reasoned that this prohibition was at odds with the one-year time period of the covenant, since if the covenant expired after a year the assumption then was that Mr. Mason's information on the company and its clients would no longer be current at that time, and therefore the seventeen-year restriction was even more excessive as it was therefore unreasonable. The Court also pointed out that since the restrictive convenant contained a clause protecting trade secrets that the clause on employment restrictions was even less defensible given that other elements of the covenant protected the company in that regard. The Court therefore declared that the restrictive covenant was unenforceable. Read-the-whole-case rating: 2.

United Stated of America v. Khadr. Abdullah Khadr was abducted by Pakistan's Inter-Services Intelligence Directory (the "ISI"), who were in turn paid by the United States for that purpose. Mr. Khadr was secretly held in detention for fourteen months, then for another nine months before Mr. Khadr was repatriated to Canada. The United States requested extradition, which failed when the judge of the Superior Court who considered the case deemed the violations of Mr. Khadr's human rights to be "shocking and injustifiable," and ordered a stay of proceeding based on abuse of process. The Attorney General of Canada (acting for the USA) appealed the stay on the basis that the extradition judge's stay was outside of his jurisdiction, and alternatively that his case did not qualify for a stay.

The Court dismissed the appeal. Firstly, the Court stated that the residual power of a Superior Court Judge to order a stay to remedy an abuse of process was not limited strictly to procedural abuse, and that the law clearly allowed the court to order a stay where allowing a case to continue would endanger public confidence in the judicial system.

The appellant, however, proposed that s. 44(1)(a) of the Extradition Act, where the Minister of Justice is granted authority to refuse to make a surrender order at the end of the immigration process, deprived a superior court of the power to order a stay since that power created a remedy for instances of abuse of process. Some extradition cases suggests that where Charter of Rights and Freedoms issues arise and refusal to surrender is a potential remedy, that then the remedy is exclusively that of the Minister of Justice.

However, the Court of Appeal cited United States of America v. Cobb, where issues that fall within the committal stage - including the use of the stay power - are the jurisdiction of the courts. The appellant suggested that Cobb was distinguishable on the grounds that this case dealt with conduct which did not directly implicate the extradition hearing, whereas Cobb was a case where the potential extraditees were intimidated from exercising their rights to a hearing.

The Court disagreed with this analysis, pointing out that the entire basis for the stay in the first place was that the United States had perpetrated a serious misconduct in garnering its information which caused it to request extradition, which meant that the abuse of process was the root cause for the extradition hearing to happen in the first place. The Court also stated that the Attorney General's reading of Cobb was overly narrow and that common law suggested that the power for an extradition judge to stay proceedings for abuse of process was much broader than simply relating to the fairness of the hearing itself, and finally state that recognizing this power coincided with the idea that the courts should not surrender their own authority to protect their integrity to the executive.

The Court then considered whether this case qualified for a stay, given that they had clearly decided that the stay power was usable in this instance. They noted that the Attorney General had not appealed the findings of the extradition judge that Mr. Khadr's human rights violations were "shocking and unjustifiable," and then stated that the judge's findings were sufficient to trigger discretionary use of a stay in this instance. The Attorney General also submitted that the extradition judge had no jurisdiction to find that Mr. Khadr's detention had been illegal under Pakistani law, but the Court pointed out that the judge had relied upon an expert affidavit from a law professor to establish that fact.

Finally, the Court rejected the appellant's argument that the stay should be rejected on the basis that the extradition judge had not appropriately balanced the effect of the stay against the public's interest in seeing an alleged terrorist committed for extradition. The Court first stated that balancing the merits of a stay should only occur in borderline cases of abuse, rather than in clear cases, then pointed out that the Attorney General itself had conceded that Mr. Khadr was liable under the Criminal Code of Canada for terrorist acts committed in another country and that therefore, even if balancing were necessary, the fact that other means existed to address the public's interest in this case would tip that balance in favour of the stay. Read-the-whole-case rating:4.

- Christopher Bird, Toronto

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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

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Ontario Court of Appeal Sets Aside $1.9 Million Award for "Client Poaching:" Restrictive Covenant Unenforceable

In an important decision that reaffirms the limited enforceability of non-competition covenants in Canadian employment agreements, the Court of Appeal for Ontario has reversed a September, 2007 trial ruling of Mr. Justice G.E. Taylor of Ontario' Superior Court of Justice.

At trial in H. L. Staebler Company Limited v. Tim James Allan, et al., two Kitchener, Ontario insurance salespersons and their new employer were ordered to pay damages of $1.9 million to the salespersons' former brokerage, H.L. Staebler Company Limited.

Staebler commenced the action after its salespersons left to join Stevenson and Hunt Insurance Brokers Limited, a competing brokerage. The employees brought their entire books of business to their new employer when they changed brokerages.

In ruling against the employees, the trial court enforced a two-year non-solicitation covenant that precluded them from "doing business" with the clients of their former brokerage for a two year period following any termination of their employment with Staebler. The court also held that Stevenson and Hunt was liable for inducing the salespersons to breach their employment agreements with Staebler.

• For our report on the trial court's decision see: Former Employees and New Employer Ordered to pay $1.9 million for "Client Poaching" as Ontario Court Enforces Two-Year Non-Solicitation Covenants.

On appeal, Madame Justice Eileen Gillese, for the Court, reviewed the law applicable to non-competition and non-solicitation agreements in Ontario. The Court unanimously ruled that the restrictive covenants in this case were unreasonable in scope, given the non-managerial roles of the salespersons involved and the "overly broad" restraints imposed by the covenants upon the salespersons' ability to freely compete in the industry:

[33] There is no dispute about the legal principles that apply when determining whether a restrictive covenant in an employment contract is enforceable, as those principles have long been settled. Several decades ago in Elsley, the seminal Canadian case on this matter, Dickson J. described the principles as “well-established”.[2] He stated the test in plain terms: such a covenant is enforceable “only if it is reasonable between the parties and with reference to the public interest”.[3]

[34] This test reflects the competing principles that must be balanced when a court is called on to decide the validity of such a covenant. On the one hand, there is the “important public interest in discouraging restraints on trade, and maintaining free and open competition unencumbered by the fetters of restrictive covenants”.[4] Open competition benefits both society and the affected employees. Society benefits from having greater choice and employees benefit as they have greater employment opportunities. On the other hand, however, “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”.[5]

[35] While an overly broad restraint on an individual’s freedom to compete will generally be unenforceable, the courts must recognize and afford “reasonable protection to trade secrets, confidential information, and trade connections of the employer.”[6] In the present case, there is no suggestion that trade secrets or confidential information is involved. It is Staebler’s “trade connections” that warrant protection.

[36] Reasonableness is the mechanism by which a court decides whether a covenant is “overly broad” or is only that which is reasonably required for the employer’s protection. But how is a court to determine whether any given restrictive covenant is “reasonable”? Elsley offers a framework for making such a determination. The starting point is “an overall assessment of the clause, the agreement within which it is found, and all of the surrounding circumstances”.[7] Thereafter, three factors must be considered. First, did the employer have a proprietary interest entitled to protection? Second, are the temporal or spatial features of the covenant too broad? And, third, is the covenant unenforceable as being against competition generally, and not limited to proscribing solicitation of clients of the former employer?[8]

...[54] My view that Staebler has not discharged the burden of establishing that the Restrictive Covenant was reasonable[11] as between the parties is reinforced on a consideration of the third factor.

[55] A non-solicitation clause is sufficient in conventional employer/employee situations.[12] The Employees were two of ten commercial insurance salespeople that worked for Staebler. They did not play an exceptional role in the Staebler business – they were ordinary salespeople. They were not managers, directors or key employees. They did not stand in a fiduciary relationship with Staebler.

[56] Although the Employees had close personal relationships with their clients, that is the industry norm. Those relationships were not exclusive; other Staebler employees served the clients in various capacities. This is an important difference between the role that the Employees played at Staebler and that of Mr. Elsley who “was the business”.[13] Another significant difference between the present case and Elsley is that the Employees had no special knowledge of or influence over the Staebler business whereas Mr. Elsley “had control of [the employer’s] trade connections”.[14] Furthermore, and again in contradistinction to Elsley, there was an imbalance of bargaining power between the Employees and Staebler when the employment contracts were negotiated whereas Mr. Elsley bargained as an equal when selling his business and then carried on as its general manager.

[57] The 50 mile radius clause which Staebler had with five of its other commercial salespeople is significant. Under its terms, those employees could solicit their clients and customers and conduct business with Staebler clients so long as they did so outside of a 50 mile radius of the Waterloo region. No explanation was given to justify this differential treatment among Staebler’s commercial insurance salespeople which leads me to conclude that Staebler itself viewed the 50 mile radius clause as sufficient protection of its interest. Clearly, the terms of the Restrictive Covenant are far more restrictive than are those of the 50 mile radius clause.[15]

[58] Other provincial appellate courts have affirmed that suitably restricted non-solicitation clauses are likely to be found to be reasonable for “ordinary” salespeople in the insurance brokerage industry whereas non-competition clauses are not. See, for example, Valley First Financial Services Ltd. v. Trach, [2004] B.C.J. No. 1127 (C.A.).

[59] It follows from my determination that the Restrictive Covenant is not enforceable that Stevenson & Hunt are not liable for inducing a breach of contract.

For the full text of the Court of Appeal's ruling, see: H.L. Staebler Company Limited v. Allan, 2008 ONCA 576 (CanLII)

- Garry J. Wise, Toronto

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