Can a judge “rewrite” a restrictive covenant in an employment contract that is ambiguous or unreasonable, to avoid the clause being found enforceable? The Supreme Court of Canada recently addressed this question in Shafron v. KRG Insurance Brokers (Western) Inc., and endorsed a restricted approach that allows a judge to make changes only in very limited circumstances, where the substance of the covenant will not be impacted or re-written.
The events of the case began in 1987, when Mr. Shafron sold his insurance agency to KRG. From 1987 to 2001, Mr. Shafron was employed by KRG pursuant to a series of employment contracts. Each employment contract contained a similarly worded restrictive covenant, pursuant to which Mr. Shafron agreed that he would not be employed in the business of insurance brokerage within the “Metropolitan City of Vancouver” for a period of three years. In 2001, at the conclusion of his contract, Mr. Shafron began working as an insurance salesperson for another agency. KRG suedMr. Shafron, alleging he was in breach of the covenant not to compete.
The trial judge concluded that the term “Metropolitan City of Vancouver” was neither clear nor certain and, in any event, was unreasonable. The Court of Appeal agreed that the term “Metropolitan City of Vancouver” was ambiguous, but applied the doctrine of “notional severance” to construe it as applying to the City of Vancouver, the University of British Columbia Endowment Lands, Richmond and Burnaby. The Court of Appeal also concluded that the geographical area and the three-year duration were reasonable and enforceable. Mr. Shafron appealed to the Supreme Court of Canada.
The Supreme Court began its analysis by reviewing the law relating to restrictive covenants. The Court noted that there is a presumption that restrictive covenants are unenforceable, but may be justified by the special circumstances of a particular case, provided the restriction is reasonable. The Court noted the distinction between covenants obtained as part of a sale of a business and covenants obtained as part of an employment relationship. For covenants obtained as a result of an employment relationship, the Court noted that the covenant would be subjected to more “rigorous scrutiny” because of the inequality of bargaining power between the parties, a factor not typically present in commercial dealings.
The Supreme Court noted that judges had used two types of “severance” to deal with unenforceable covenants: “blue pencil” severance and “notional” severance. Blue pencil severance involves the court striking out certain words in a contract, where it can be done without affecting the meaning of the rest of the terms. Notional severance involves “reading down” or narrowing an illegal provision in a contract in order to make it legal and enforceable.
The Supreme Court concluded that judges may not notionally sever covenants in employment contracts. In refusing to allow judges to effectively “rewrite” unenforceable clauses, the Court was concerned in part with employers extracting onerous covenants from employees on the hope that they would comply with it or, if they did not comply, that the covenant could later be narrowed by a judge to make it enforceable. With respect to blue pencil severance, the court concluded that it may be used “sparingly”, and only in cases where the words removed are trivial to the restrictive covenant.
On the facts of the case, the Supreme Court concluded that the Court of Appeal was wrong to substitute its views of the geographic scope of the covenant, given there was no recognized meaning for the phrase “Metropolitan City of Vancouver” and a lack of agreement between Mr. Shafron and KRG as to its meaning. The Supreme Court also rejected KRG’s argument that blue pencil severance should be applied to strike out the word “Metropolitan”, leaving only the words “City of Vancouver”, because there was no evidence that the parties would have agreed to that deletion. In the end, the Supreme Court agreed with the trial judge that the covenant was ambiguous and unenforceable, and that the action should be dismissed.
The Supreme Court did not address the reasonableness of the three-year duration of the covenant. Although the Court of Appeal concluded it was reasonable, employers should be cautious about that finding; in most cases, it would be very difficult to convince a judge that a three-year prohibition on competition arising from an employment relationship was reasonable and necessary for the protection of the employer’s business. A duration of one year or less for a non-competition covenant is much more likely to be enforced, assuming it is otherwise reasonable.
The decision in Shafron makes it clear that employers will not be able to rely on judges to fix unenforceable restrictive covenants, including covenants dealing with competition or solicitation. Accordingly, to ensure protection, employers should examine existing covenants and seek legal advice to ensure that they are unambiguous and reasonable, with regard to scope, duration and geographical restraint.