The Ontario Court of Appeal decision in H.L. Staebler Company Limited v. Allan (2008 ONCA 576) contains a useful discussion of when restrictive covenants (non-comps and non-solicitation) in employment contracts are enforceable. These kinds of covenants are very common in employment contracts.
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 Supreme Court of Canada case on this matter, Dickson J. described the principles as “well-established.” 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.”
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.”
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, “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.”
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.” 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.
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.” 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?
Before turning to an assessment of the restrictive covenant and a consideration of the three factors, two additional principles that operate in this area warrant mention. The first such principle relates to the nature of the restrictive covenant. A restrictive covenant may restrain either competition or solicitation. A non-competition clause restrains the departing employee from conducting business with former clients and customers whereas a non-solicitation clause merely prohibits the departing employee from soliciting their business.
In Lyons v. Multari (2000), 50 O.R. (3d) 526 (C.A.) at para. 31, MacPherson J.A. explained the difference between the two types of clauses in the terms:
The non-competition clause is a more drastic weapon in an employer’s arsenal. Its focus is much broader than an attempt to protect the employer’s client or customer base; it extends to an attempt to keep the former employee out of the business. Usually, non-competition clauses are limited in terms of space and time.
Elsley makes it clear that a non-solicitation clause is normally sufficient to protect an employer’s proprietary interest and that a non-competition clause is warranted only in exceptional circumstances. At pages 925 and 926 of Elsley, Dickson J. wrote: The next and crucial question is whether the covenant is unenforceable as being against competition generally and not limited to proscribing solicitation of clients of the former employer. In a conventional employer/employee situation, the clause might well be held invalid for that reason.
Nevertheless, in exceptional cases, of which I think this is one, the nature of the employment may justify a covenant prohibiting an employee not only from soliciting customers, but also from establishing his or her own business or working for others so as to be likely to appropriate the employer’s trade connection through his or her acquaintance with the employer’s customers. This may indeed be the only effective covenant to protect the proprietary interest of the employer. A simple non-solicitation clause would not suffice.
Similarly, at para. 33 of Lyons, MacPherson J.A. states, “Generally speaking, the courts will not enforce a non-competition clause if a non-solicitation clause would adequately protect an employer’s interests.”
In short, a general principle flowing from Elsley and reiterated in Lyons is that a non-solicitation clause – suitably restrained in temporal and spatial terms – is more likely to represent a reasonable balance of the competing interests than is a non-competition clause. An appropriately limited non-solicitation clause offers protection for an employer without unduly compromising a person’s ability to work in his or her chosen field. A non-competition clause, on the other hand, is enforceable only in exceptional circumstances.
The other legal principle that warrants mention is this: the fact that a clause might have been enforceable had it been drafted in narrower terms will not save it. The question is not whether a valid agreement might have been made but whether the agreement that was made is valid.
This article appeared in the September 1 - 7, 2009 issue of Business in Vancouver.