As employee mobility increases, businesses are frequently relying on restrictive covenants (such as non-competition and non-solicitation clauses) to safeguard their intellectual property and other proprietary information. Departing employees are of particular concern.
Traditionally, Canadian courts considered a restrictive covenant between an employer and an employee to be a restraint of trade and unenforceable, unless you could show it was reasonably necessary to protect your business and was not injurious to the public. If the restrictive covenant was found to be unreasonable in any way, courts would strike it down completely, leaving employees free to compete with their former employers.
A 2005 B.C. Court of Appeal decision changed this ‘all-or-nothing’ approach, at least in B.C. In ACS Public Sector Solutions Inc. v. Courthouse Technologies Ltd. (ACS), the court applied the concept of ‘notional severance,’ which allows it to rewrite the offending provision to conform with the law, instead of having to strike down the provision completely. By ‘reading down’ or striking out the unreasonable terms, the court is able to enforce the substance of the restrictive covenant.
The ACS Decision
In ACS, the employer was in the business of providing jury management services. Its source code was confidential and proprietary, and had been developed by a predecessor company called Omni-Tech Systems Ltd. (OTS).
Mr. Arntsen developed software for OTS and had an ownership interest in the company. He sold his interest in OTS and its intellectual property when OTS was purchased by another company. He remained a consultant to the business. In 2001, ACS acquired the business, including assignment of Mr. Arntsen’s consulting agreement. It contained non-competition and non-solicitation covenants. The consulting agreement stated that any provision declared invalid would not affect the validity of the remaining provisions.
When ACS elected not to renew his consulting agreement, Mr. Arntsen joined Senaca Software Inc., which soon put competing jury management software on the market. Based on how quickly this occurred, ACS believed Mr. Arntsen had misused its intellectual property and applied for an injunction.
At trial, the court found that the restrictive covenant went beyond what was reasonably necessary to protect the interests of ACS. However, rather than taking the traditional approach of striking down the entire covenant, the court severed the parts of the covenant that went beyond what was reasonably necessary and enforced the altered covenant.
The B.C. Court of Appeal upheld the trial decision and approved the concept of notional severance. Thus, the enforceability of restrictive covenants is no longer an ‘all or nothing’ approach in B.C.
The Jones Decision
In Jones v. Prostar Painting and Restoration Ltd. (Jones), the B.C. Supreme Court considered the enforceability of a five-year non-competition clause in an employment context. The court found that if a non-competition clause is overly broad, the court has two options. It may decide that the clause is entirely unenforceable. Alternatively, it may choose to read down its terms to "cure the illegality while remaining otherwise as close as possible to the intentions of the parties expressed in the agreement." In this case, "on the basis of fairness," the court chose to read down the five-year restriction by reducing it to two years. The court noted that it was particularly appropriate to read down the restrictive covenant in this case, as a clause in the employment contract authorized the court to reduce any part of the non-compete the court found unreasonable, or overly broad, to make the non-compete reasonable and enforceable.
The KRG Decision
In KRG Insurance Brokers (Western) Inc. v. Shafron (KRG), the B.C. Court of Appeal’s decision indicates that restrictive covenants will continue to be carefully scrutinized, but courts will be flexible and use the concept of notional severance to give effect to the substance of the deal struck between the parties. This prevents accidents of drafting or an unfortunate choice of words determining the outcome.
In 1987, Mr. Shafron sold his insurance agency to KRG Insurance Brokers Inc. but continued working in the agency. Mr. Shafron was subject to a three-year non-compete clause covering the "Metropolitan City of Vancouver." In 2001, Mr. Shafron, unhappy with his compensation, left to join an insurance broker in Richmond. A significant number of his former customers moved their business to his new employer, and KRG sued to enforce the restrictive covenant.
Mr. Shafron challenged the enforceability of the non-compete clause on the basis that there is no recognized meaning for the phrase "Metropolitan City of Vancouver." Applying the concept of notional severance to give effect to the substance of the agreement, the court construed "Metropolitan City of Vancouver" as the City of Vancouver and the municipalities directly neighbouring it.
The court also reviewed the three-year term and found it to be reasonable under the circumstances. In doing so, the court debunked a popular view that restrictive covenants for employees that are longer than two years will be found reasonable only in exceptional cases. However, the court cautioned that each case turns on its own specific facts.
In the result, Mr. Shafron was found in violation of his covenant to KRG, and the court referred the matter to the trial court to assess damages.1
A Different Approach in Alberta
Employers in Alberta should be aware that the Alberta Court of Appeal has expressly rejected the concept of notional severance in restrictive covenant cases. In Globex Foreign Exchange Corporation v. Kelcher, the court concluded:
Employers should not be permitted to draft unreasonably broad restrictive covenants with the expectation that … the court will simply re-write the clause so as to make it enforceable.
As a result, employers in Alberta need to be particularly cautious about drafting restrictive covenants because if such covenants are found unreasonable in any way, they will be struck out completely.
Lessons for Employers
Despite the increasing trend towards upholding and enforcing restrictive covenants, it is still important to carefully consider the protections you reasonably need when you use restrictive covenants, particularly for lower-level employees. You should give specific consideration to the geographic scope and duration of the covenants, especially for non-compete clauses.
Even in B.C., it is not advisable to use broad restrictions and rely on the courts to read them down. This increases the risk of unnecessary litigation. Another risk is that a court will decide the covenant is unenforceable instead of applying notional severance.
Finally, you should ensure that your employment agreements contain a severability clause authorizing the court to apply the concept of notional severance