Written By Carl Cunningham
Two recent significant decisions offer a reminder of the importance of ensuring that the restrictive covenants in your company's contracts are clear and reasonable. In Shafron v. KRG Insurance Brokers (Western) Inc., the Supreme Court of Canada (SCC) refused to enforce an ambiguous noncompetition clause. In H.L. Staebler Company Ltd. v. Allan, the Ontario Court of Appeal overturned the trial judge's decision and refused to enforce a “hybrid” type of no-contact clause because it was not reasonable.
In our Employment Services Update last Fall,Supreme Court Clarifies Post-employment Duties, we updated you on the SCC's decision in RBC Dominion Securities Inc. v. Merrill Lynch Canada Inc. The RBC decision was significant for confirming that departing employees are generally free to compete against their former employer in the absence of an enforceable contractual restriction. While the RBC decision is a reminder to employers to use written contracts, the decisions of Shafron and H.L. Staebler are important for helping you understand whether your contractual restrictive covenants are sufficiently clear and reasonable and therefore likely to be enforced.
Contractual Restrictive Covenants
A restrictive covenant is a type of clause that may be included in an employment contract or other written agreement between an employer and the employee and places restrictions on the employee's post-employment activities. The scope of the potential restrictions placed on the departing employee's activities may vary. A non-solicitation clause may limit the employee's ability to solicit the business of one of the company's customers or to persuade one of the company's employees to cease employment with the company. A non-competition clause may limit the employee's ability to work in or carry on a business activity that is competitive with the employer's business.
The Reasonableness Requirements
The primary factors the court will review to determine whether a restrictive covenant is reasonable are:
- Does the employer have a proprietary interest entitled to protection (e.g. interest in “book of business”)?
- Are the geographic limitations and time limits in the covenant reasonable?
- Is the clause reasonable in its restricted activities (e.g. is it against competition generally)?
Overbroad and Unenforceable Covenants
The Ontario Court of Appeal's decision in H.L. Staebler provides a recent example of the type of restrictive covenant that a court will likely find unreasonable (i.e., overly broad and unenforceable). The restrictive covenant in that case stated:
In the event of termination of your employment with the Company, you undertake that you will not, for a period of two consecutive years following said termination, conduct business with any clients or customers of H.L. Staebler Company Ltd. that were handled or serviced by you at the date of your termination.
The trial judge found that the above “hybrid” clause which combined elements of a non-solicit and a non-compete, was reasonable. One of the reasons the trial judge considered this provision reasonable was because it did not prohibit solicitation of all of the employer's clients, only the conducting of business with those clients that were handled or serviced by the employee at the date of his or her termination.
The Ontario Court of Appeal held the above clause was not a “hybrid” clause, but a noncompetition clause and that it was overbroad and unenforceable. The clause contained no geographical limitation. The effect was that the employees were prohibited from doing business with their former clients even if the employees and the former clients relocated a far distance from the employer's business (e.g. outside the province). In addition, the restrictive covenant did not restrict the prohibited business activity to competitive business activities and simply prohibited conduct with the clients or customers (e.g. they could not sell non-competitive services).
Ambiguous Clauses Not Enforceable
In addition to being reasonable, the restrictive covenant must be clear and unambiguous. In Shafron the SCC confirmed that it is not appropriate for a court to rewrite an ambiguous restrictive covenant. The ambiguous portion of the restrictive covenant was the term “the Metropolitan City of Vancouver”. There is no common or defined understanding of what areas are included in “Metropolitan” Vancouver and the British Columbia Court of Appeal applied the concept of notional severance; and substituted the term “the City of Vancouver, the University of British Columbia Endowment Lands, Richmond and Burnaby”.
The SCC was not prepared to vary from the general rule that a restrictive covenant in an employment contract that is ambiguous in its terms will be void and unenforceable. The SCC overturned the Court of Appeal decision and held it was inappropriate to extend the concept of notional severance to the case of restrictive covenants in employment contracts. For public policy reasons the SCC did not want to invite “the employer to impose an unreasonable restrictive covenant on the employee with the only sanction being if the covenant is found to be unreasonable, the court will still enforce it to the extent of what might validly have been agreed to.”
In addition, the Supreme Court restricted the application of another severance technique known as use of the “blue pencil” (i.e., strike or remove a portion of the unenforceable or ambiguous clause). This technique will be applied narrowly and only in cases where the court would be severing parts of an invalid covenant that are “trivial or technical” and not part of the main purpose of the clause.
What This Means to You
The decisions in H.L. Staebler and Shafron remind us that it is important to ensure all restrictive covenant clauses in your employment contracts are (1) reasonable and (2) clear and unambiguous. The more the clauses are specifically tailored to the individual, the more likely they will be upheld. The following are some suggestions for increasing the likelihood that your restrictive covenants will be enforceable:
- Narrowly define the description of a competitive business.
- Narrowly define the geographic scope of the restrictive covenants.
- Narrowly define the temporal scope of the restrictive covenants.
- Limit the list of customers/clients that the employee cannot solicit.
- Draft non-solicitation and non-competition provisions as separate clauses.
- Include a clause outlining the purpose of requiring the employee to agree to the restrictions.
- Include a severability clause.
Many of our clients are in the process of reducing the size of their workforce. Prior to implementing certain individual terminations, consider whether the restrictive covenants for your affected employees are likely to be enforceable. Please contact one of our employment services lawyers to discuss any issues you have relating to a review of your existing restrictive covenants or the drafting of new restrictive covenants for your employment contracts.