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Court of Appeal strikes down unreasonable non-competition clause
As a general rule, restrictive covenants, such as non-competition clauses in employment agreements, are unenforceable. Such covenants are seen by the courts to interfere with an individual’s freedom to trade and to discourage open competition. However the law also recognizes that employers have the right to protect their trade secrets, confidential information, and trade connections. The law recognizes as well that parties have the freedom to contract on the terms they choose. The result of these competing interests is a tentative balance in which Canadian courts have carved out an exception to the general rule: if the restrictive covenant is reasonable in the activity it prohibits, and in terms of its geographic and temporal scope, it will be upheld.
In Mason v. Chem-Trend Limited Partnership (May 2011), the Ontario Court of Appeal considered whether it was reasonable to completely prohibit a former employee from any form of competition against his former employer for one year. The Court of Appeal ruled that the restrictive covenant in question was overly broad in restricting the employee’s activities and therefore was unreasonable and unenforceable.
THE RESTRICTIVE COVENANT
The appellant, Mr. Mason, was employed as a salesperson by Chem-Trend, a manufacturer of release agents and chemical products. When he was hired Mr. Mason was required to sign the Chem-Trend Confidential Information Guide and Agreement. This agreement contained the following restrictive covenant:
I agree that if my employment is terminated for any reason by me or by the Company, I will not, for a period of one year following the termination, directly or indirectly, for my own account or as an employee or agent of any business entity, engage 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, or take any action that will cause the termination of the business relationship between the Company and any customer, or solicit for employment any person employed by the Company.
In July 2009, after 17 years of employment, Mr Mason was dismissed by Chem-Trend, allegedly for cause. In order to determine whether, and to what extent, he was permitted to compete with his former employer, Mr. Mason brought an application for a declaration from the court that the above restrictive covenant was unenforceable.
THE APPLICATION JUDGE
The application judge followed the seminal decision of the Supreme Court of Canada in J.G. Collins Insurance Agencies Ltd. v. Elsley Estate (1978) (“Elsley”). The judge considered the three factors necessary to determine whether a restrictive covenant is reasonable: geographic scope, the activity that is restricted, and the time period of the restriction.
Although the geographic scope of the restriction was world-wide, the application judge accepted this as reasonable based on the international nature of the Employer’s operations. The judge also found that it was reasonable to restrict any competitive activity on the part of Mr. Mason because of his former access to confidential information of the Employer, and his technical knowledge of the industry. Finally, the application judge found that the one-year restriction was relatively short compared to other cases. This served to balance the more onerous restrictions in relation to geographic scope and prohibited activities. The judge ruled that the restrictive covenant was unambiguous and reasonable, and therefore enforceable. Mr. Mason appealed to the Court of Appeal.
THE ONTARIO COURT OF APPEAL
Citing its own decision in H.L. Staebler Company Ltd. v. Allan (2008), the Court of Appeal listed the governing principles that apply to determine whether a restrictive covenant in the employment context is enforceable. These principles incorporate the Supreme Court’s decision in Elsley and were summarized by the Court of Appeal as follows:
- To be enforceable, the covenant must be “reasonable between the parties and with reference to the public interest.”
- The balance is between the public interest in maintaining open competition and discouraging restraints on trade on the one hand, and on the other hand, the right of an employer to the protection of its trade secrets, confidential information and trade connections.
- “The validity, or otherwise, of a restrictive covenant can be determined only upon an overall assessment of the clause, the agreement within which it is found and all of the surrounding circumstances.”
- In that context, the three factors to be considered are:
1) did the employer have a proprietary interest entitled to protection?
2) are the temporal or spatial limits too broad?
3) is the covenant overly broad in the activity it proscribes because it prohibits competition generally and not just solicitation of the employer’s customers?
UNAMBIGUOUS BUT STILL UNREASONABLE
The Court of Appeal agreed with the application judge that the plain words of the clause were clear and understood by the appellant and therefore were unambiguous. The Court of Appeal did not agree, however, that the non-competition clause was reasonable. In the Court of Appeal’s view, completely prohibiting the appellant from competing with the Employer was too restrictive of the appellant’s activities.
The Court of Appeal noted that when the employment agreement was examined as a whole, there were other clauses that provided protection to the Employer. In particular the following provision was seen to protect trade secrets and other confidential information:
I will not at any time, either during or after my employment with the Company, use or disclose to others any trade secrets or confidential information of the Company, except as required in performing my duties for the Company or with the Company’s written consent.
The Court of Appeal also found that it was impossible for the appellant to know with which potential customers he was prohibited from doing business. The scope of the prohibition was “any business entity which was a customer of the Company during the period in which [he] was an employee of the Company.”
The appellant had been employed by the Company for 17 years and the restriction was not limited to his own customers. Rather it included every customer of the Company during that 17-year period. Mr. Mason did not have access to the customer lists of his former Employer, and therefore the Court of Appeal found that the appellant had no way of knowing whether a potential contact was, or had been, a customer of the Company during the last 17 years.
This restriction was not only ambiguous in its practical implementation, but it also effectively prohibited the appellant from competing with the respondent in any way for one year. The Court of Appeal stated:
After conducting the balancing process between the rights of the respondent to protect its trade secrets and customer information, and the public interest in free and open competition, in the context of the agreement as a whole and the role of the appellant in the company as a salesman, I conclude that the complete prohibition on competition for one year is overly broad as well as unworkable in practice and makes the restrictive covenant unreasonable and unenforceable.
The Court of Appeal allowed the appeal and granted the declaration that the restrictive covenant was unreasonable and therefore unenforceable by the Employer. The Court of Appeal granted the appellant costs of the appeal fixed at $25,000.
In Our View
Employers should keep in mind that Canadian courts employ different approaches to their consideration of restrictive covenants, depending on the context. For example, restrictive covenants in agreements for the sale of a business are generally subject to less searching scrutiny by the courts than restrictive covenants arising in the employment context. In order to sell a business, the vendor will often need to commit to the purchaser that he or she will refrain from competing with the purchaser. The courts have recognized this need and will generally take a less strict view of what is reasonable for restrictive covenants in the sale of a business, as compared to those which arise in the employment context.
For further information, please contact Jock Climie at (613) 940-2742.
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