Restrictive covenants

Restrictive covenants
Many U.S. businesses doing or seeking to do business in Canada are initially attracted to the country due to its cultural similarities with, and close geographic location to, their own.

While there are similarities, there are extraordinary differences as well, including rules respecting the enforcement of restrictive covenants. Generally, restrictive covenants in Canada are less enforceable than in many U.S. states.

At a practical level the range of remedies available to moving parties are narrower as well. A number of important recent Canadian court decisions have further widened the gap and made it more difficult for Canadian employers to enforce restrictive covenants.

In the U.S., the enforceability of non-competition, non-solicitation, and confidentiality covenants varies from jurisdiction to jurisdiction. While some states explicitly prohibit the use of restrictive covenants in employment contracts, many others will enforce them if drafted appropriately.

In most of the common-law Canadian provinces, and in particular in Ontario, non-competition clauses are only enforceable in very limited circumstances and only when the covenant is absolutely necessary to protect the former employer’s legitimate proprietary interests and is reasonable in its scope and unambiguous in its terms. 

The courts consider the geographic and temporal scope of the limitation in order to be reasonable. Canadian courts have consistently held that non-competition covenants will not be appropriate where a non-solicitation covenant would suffice to protect the employer’s interests.

Non-solicitation and confidentiality covenants generally tend to be more enforceable than non-competition covenants.

Many state courts will rewrite or read down overly broad covenants to render them enforceable in the U.S. In contrast, Canadian courts have traditionally been hesitant to rewrite or modify, “blue pencil,” a covenant.

In Shafron v. KRG Insurance Brokers (Western) Inc., the Supreme Court of Canada took this concept one step further and held it is always inappropriate to apply the doctrine of notional severance, reading down a contractual term to make it enforceable. The Supreme Court’s decision in Shafron is public-policy driven.

The court reasoned that allowing “blue pencilling” or notional severance would simply encourage employers to draft overly broad restrictive covenants, with the only sanction being the court will enforce what could have been validly agreed to by the parties.

This decision requires parties to draft reasonably or risk the contract being unenforceable. The only language that will ever be removed using “blue-pencil” severance, the court held, is trivial and severable language unconnected to the purpose of the contract. In effect, the court will not allow “blue-pencilling” or descending scope clauses.

Covenants seeking to restrain employees from carrying on business with the clients and customers of the employer will only rarely be enforceable. In H.L. Staebler Company Ltd v. Allan an employee was alleged to have breached a covenant that provided he would not “conduct business with any clients or customers” for two years. 

The trial court characterized the covenant as a hybrid clause, restraining both competition and solicitation, and found that it was enforceable.

The appeal court disagreed, finding the covenant was a non-competition clause because it restricted the employee from conducting business with former clients. The appeal court held the clause must meet the more restrictive test applicable to non-competition covenant and the clause was unreasonable and unenforceable because it had no geographic limit.

Many Canadian employers currently have similar covenants in employment contracts with their employees. These covenants may no longer be enforceable in light of the decisions.

The employer must renegotiate with employees and provide sufficient consideration for the contractual change in order to replace these unenforceable covenants.

An improperly drafted restrictive covenant may endanger the vital business interests they are designed to protect. Employers should avoid broadly drafted covenants in preference to covenants with reasonable geographic and temporal limits in order to ensure these interests are protected.

Employers should ensure non-competition and non-solicitation covenants are included separately in contracts to enhance severability, and non-competition covenants should be limited to key employees.

Where employers use choice of law or exclusive jurisdiction clauses, employers should draft the clause to allow the employer to “follow” a breach to other provinces or foreign jurisdictions in order to be able to move for injunctive relief.

Henry Dinsdale and Jeff Goodman are labour and employment law partners with Heenan Blaikie LLP in Toronto.

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