Supreme Court Affirms the Enforceability of Restrictive Covenants in Commercial Agreements

Written By Ranjan K. Agarwal

It is trite law that restrictive covenants (non-competition and non-solicitation clauses) are a restraint on trade and, generally, difficult to enforce in employment contracts. The employer has the onus of proving that the covenant is reasonable as between the parties in terms of its scope, geography and temporal limit and reasonable in the public interest.

The law on restrictive covenants in agreements for the sale of business is less clear though the courts are less rigorous in scrutinizing them. The lack of clarity in the law is exacerbated in cases where the vendor of the business agrees to continue working for the business post-acquisition.

In its recent decision Payette v Guay inc, the Supreme Court of Canada clarified the law in this area. In particular, the court makes clear that “in the commercial context, a restrictive covenant is lawful unless it can be established on a balance of probabilities that its scope is unreasonable.”

Facts

In October 2004, Yannick Payette and Louis Pierre Lafortune sold their crane rental business to Guay inc., a crane rental company. The purchase price was $26 million, including $14 million in cash.

The purchase/sale agreement provided that Payette and Lafortune would not, for a period of five years after their employment ended, compete against Guay or solicit its customers or employees.

As part of the purchase/sale agreement, Payette and Lafortune agreed to work as full-time consultants for Guay. At the end of this six-month period, Payette agreed to become a full-time employee of Guay, entering into an employment contract with Guay.

In August 2009, Guay terminated Payette's employment without cause. Payette and Guay negotiated a severance package. At that time, Payette asked Guay's consent to accept a job with a company not involved in the crane rental business. Guay consented.

In fact, Payette began working for Mammoet Crane Inc., a direct competitor to Guay in the crane rental business. Seven of Guay's most experienced employees quit to work with Mammoet.

Guay was granted an interlocutory injunction restraining Payette from working for Mammoet until trial. At the hearing of the case on its merits, the Superior Court found that the covenants were unenforceable, largely on the basis that they were employment covenants.¹ The Court of Appeal disagreed, holding that the covenants were commercial covenants. The Supreme Court of Canada unanimously upheld the Court of Appeal's decision.

Discussion

The Supreme Court's decision clarifies the law governing restrictive covenants in commercial agreements.

First, the rules governing restrictive covenants relating to employment do not apply “with the same rigour or intensity” in commercial agreements. In employment contracts, the courts assume that there is an imbalance of power between the employer and employee. That presumption does not exist in commercial agreements, where the purchaser's objective in negotiating a restrictive covenant is to protect its investment by building “strong ties” with its new customers, suppliers and employees. In practical terms, this means that Payette, as the vendor, had the burden of proving that the covenants are unreasonable in scope, duration and geography (as opposed to the employer in employment covenants).

Second, if the covenant is a “hybrid” (as in this case), the court will attempt to clearly identify the reason why and for what purpose the covenant was entered into in order to determine if it is linked to the employment contract or the commercial agreement. In this case, the court held that Payette agreed to the restrictive covenants as part of the sale of his business not as part of his employment with Guay.

In reaching this conclusion, the court identified a number of factors:

• the covenants included the words “in consideration of the sale”;
• Guay acquired Payette's goodwill, skilled employees and customers—if it could not protect this investment, it would not have concluded the transaction;
• at the time of his dismissal, Payette's employment was governed by a new employment contract, which did not include any restrictive covenants; and
• the fact that the covenants referenced Payette's employment is only relevant for determining the start and end dates of the covenants, which the court described as “coherent and pragmatic”.

Third, covenants in a commercial agreement will be reasonable provided that the scope, geography and temporal duration are limited to “whatever is necessary for the protection of the legitimate interests” of the purchaser. In deciding the reasonableness of the covenants, the courts will consider the “sale price, the nature of the business's activities, the parties' experience and expertise and the fact that the parties had access to the services of legal counsel and other professionals.”

In this case, the court found that Payette and Guay had “lengthy negotiations”, they were both “well-informed” and advised by “legal and accounting professionals”, leading to the conclusion that they bargained on equal footing and equal terms. In this context, the court concluded that the term of the covenants (five years from the date of Payette's employment ending) and territory (Québec) were both reasonable and upheld the covenants.

Conclusion

This case is a welcome clarification of the law in this area. It makes clear that sophisticated and well-advised parties will be held to the contractual promises. The court also identifies the type of evidence that will be relevant to proving the reasonableness of restrictive covenants in commercial agreements, including the terms of the sale and the scope of the acquired business. 

Notes

1. Article 2095 of the Civil Code of Québec states: "An employer may not avail himself of a stipulation of non-competition if he has resiliated the contract without a serious reason or if he has himself given the employee such a reason for resiliating the contract."