In Martin v ConCreate USL Limited Partnership(1) the Ontario Superior Court of Justice set out an analytical framework for evaluating whether a covenant in restraint of trade is enforceable, despite the general rule that such covenants are contrary to public policy and void. The framework consolidates the significant tests and rules regarding covenants in restraint of trade and is intended to be applied to covenants arising in an employment context, covenants connected to a sale or commercial transaction, or a hybrid of these two situations where an employment contract is entered into as a condition of a sale or commercial transaction.
The applicant, Derek Martin, signed an employment agreement - which included non-compete and non-solicitation covenants - with the respondents ConCreate USL Limited Partnership and Steel Design and Fabricators (SDF) Ltd, as part of the sale of two businesses in which Martin was a minority shareholder.
As a condition of the sale of the businesses, Martin agreed to serve as president of ConCreate and SDF. In exchange for the sale of the businesses and his promise to act as president, Martin received an indirect interest in ConCreate and SDF in the (unappraised) amount of C$6.5 million.
Martin's employment was subsequently terminated before the end of the term specified in his employment agreement, purportedly without cause. Following his termination, Martin incorporated his own business and hired SDF and ConCreate employees. His new business secured at least C$34 million of contract awards within six months of operations.
SDF and ConCreate commenced an action to restrain Martin from breaching the non-compete and non-solicitation covenants. Martin sought a declaration from the court that the non-compete and non-solicitation covenants were unenforceable as an illegal restraint of trade. This update deals only with Martin's application, which was ultimately dismissed.(2)
A contract in restraint of trade is one in which a party agrees to restrict his or her liberty to carry on trade with other persons. Such contracts are contrary to public policy and are void unless they are justified as being reasonable with respect to the interests of both the parties and the public. Where economic activity depends on eliminating competition or solicitation, a restraint of trade may be justified and enforceable.
In determining whether the non-solicitation and non-compete agreements in this case were enforceable, the court undertook a detailed review of the common law in respect of covenants in restraint of trade and developed the following analytic framework:
- Whether a covenant in restraint of trade is enforceable will depend on the facts of the particular case. A court will examine the nature of the business, including its trade secrets, confidential information, trade connections and the role of the person to be bound by the covenant - including whether he or she is an ordinary employee, in a senior position or in a position of influence.
- It must be must be determined whether the covenant restrains trade and, if so, whether it is a non-competition clause or a less intrusive non-solicitation clause.
- It must be determined whether the restraint constitutes an exceptional case in which restraints of trade are permitted.
A covenant is unreasonable and unenforceable if it is ambiguous. A covenant is ambiguous if:
- it does not clearly define the prohibited activities, the territory of its operation and the time of its operation; or
- the person bound by the covenant cannot predict what activities are precluded by the covenant.
- Restraints of trade associated with employment contracts must be distinguished from restraints of trade associated with the sale of a business. Restraints of trade in an employment context are subject to a more rigorous analysis of reasonableness, given that employees typically have limited bargaining power. Where an employment contract is part of a vendor and purchaser contract, courts must determine whether to scrutinise the reasonableness of the contract as an employment contract or as a commercial or sale contract.
- The restraint must be justifiable as being reasonable between the parties. The party seeking to enforce the covenant bears the onus of establishing that it is reasonable as between the parties.
- Reasonableness is determined in light of the circumstances existing at the time the covenant was made, including the parties' reasonable expectations of the future prospects of the business.
- A party must have a legitimate business or property interest that requires the protection of a restraint on trade in order to enforce a covenant in restraint of trade. The covenant may not go further than necessary to adequately protect the interest.
The scope of the covenant must be reasonable in respect of:
- the extent of the activities prohibited;
- the territory covered by the covenant; and
- the duration of the prohibition.
- If the covenant overreaches in scope, it is unreasonable and unenforceable, subject to the severance doctrine.
- Even if a covenant is reasonable between the parties, it must also be reasonable with respect to the interests of the public. The onus is on the party seeking to avoid enforcement to show that the covenant is not in the public interest.
- The very limited doctrine of severability may apply if the covenant is not reasonable.
The court commented in some detail on the doctrine of severability. Where a contract permits severance, a court may either remove part of a covenant (blue-pencil severance) or read down a covenant (notional severance) to give effect to the intention of the parties. In the employment context, notional severance is not available and blue-pencil severance may be resorted to in only rare cases where the part being removed is trivial and not part of the main purport of the restrictive covenant. The doctrine of severance will not be used to rewrite a contract.
Although not mentioned by counsel, the court specifically raised the general billposting rule, which provides that when an employee is dismissed without cause, the employer cannot enforce a restrictive covenant that is otherwise binding on the employee.(3) The court made no findings in this regard, but mentioned it twice as a potential argument that Martin could raise at trial.
The court applied its analytical framework to the facts of the case and concluded that the non-solicitation and non-competition covenants were justified and enforceable. It specifically addressed arguments respecting the ambiguity of the covenants, whether they were connected to the employment or sale agreement and whether their scope was overbroad. The court's primary points are summarised as follows:
- The covenants provided advance notice of the prohibited activities and were not ambiguous(4) - phrases such as 'in any matter whatsoever', 'with any other person or persons', 'be interested in', 'be concerned with' and 'otherwise have a financial interest in' did not render the covenants ambiguous or uncertain. Rather, the covenants were capable of interpretation and provided Martin with advance notice of the prohibited conduct.
- The covenants were connected to the sale of the business. Deference was therefore given to the contractual autonomy of the parties(5) - although the covenants were contained within the employment agreement, they were connected to the sale of the business. The covenants were negotiated by capable counsel as part of the sale, which was conditional upon Martin signing the employment agreement, including the covenants. Therefore, it was not necessary to analyse the reasonableness of the covenants with the same scrutiny as would be applied if the covenants were connected only to an employment contract. The court deferred to the parties' contractual autonomy, noting that where they have equal bargaining power "it is only in exceptional circumstances that the courts are justified in over-ruling the parties' judgment as to what is reasonable in the respective interests".(6)
- The scope of prohibited activities may be based on the reasonable future expectations of the business(7) - although the predecessor companies did not engage in all the activities enumerated in the sale agreement and prohibited by the covenants, the description of business activities was not overbroad. The enumerated business activities were based on the reasonable future expectations of the parties at the time of contracting. The clear intent was "to prohibit Mr Martin from being a rival in the business endeavours that ConCreate and SDF had already staked out for themselves"(8) and the prohibitions did not go further than necessary to protect these business endeavours.
- The business was mobile. The scope of the territory covered by the covenants was not over-reaching(9) - the territory included in the covenants was not over-reaching. Although the predecessor companies had not done business in every province, they had done business across Canada, thereby displaying the ability and mobility to do business in the remaining provinces. It was clear that the parties envisioned a national scope for the businesses during their negotiations for the purchase and sale of the businesses.
- The duration of the covenants was not unreasonable(10) - the duration of the covenants was connected to Martin's ownership of an indirect interest in the businesses, and Martin's ability to divest himself of his indirect ownership had certain waiting periods attached to it. The court held that it was not reasonable to expect that Martin would not compete with his own company while he was an owner. In any event, the longest duration of the covenants was three and a half years, which was not unreasonable. In calculating the duration of the covenants, the court explicitly set aside consideration of the fact that Martin's right to dispose of his units could be subject to approval of lenders. It found it significant that as a part of the agreements, Martin acknowledged the reasonableness of the covenants in restraint of trade.(11)
The court's framework encapsulates the major common law tests and rules respecting the enforceability of covenants in restraint of trade. Its analysis in this case provides useful guidance in situations where a covenant in restraint of trade is connected to a sale or commercial transaction, despite the fact that it appears in an employment contract. In applying its framework, the court appropriately connected the covenants to the sale of the businesses, and accordingly showed deference to the contractual autonomy of the parties and an unwillingness to interfere with the bargain that they had reached.
The court made two references to the general billposting rule and suggested that the rule was available to Martin at the trial of the main action. If Martin pursues this strategy, it will be interesting to see how Ontario courts will apply the rule in this context, and whether an employer who purportedly repudiated a contract of employment is precluded from enforcing the covenants in restraint of trade within the employment contract, where the employment contract and covenants were negotiated in the larger context of a purchase and sale agreement.
For further information on this topic please contact Norm Emblem or Kathleen Burke at Fraser Milner Casgrain LLP by telephone (+1 416 863 4511), fax (+1 416 863 4592) or email (firstname.lastname@example.org or email@example.com).
(1) Martin v ConCreate USL Limited Partnership, 2012 ONSC 1840 (CanLII) [Martin].
(2) The Court of Appeal for Ontario will hear Martin's appeal on November 7 2012.
(3) General Bill Posting Company v Atkinson  AC 118.
(4) Martin, paragraphs 92 to 98.
(5) Martin, paragraphs 99 to 104.
(6) Martin, paragraph 104.
(7) Martin, paragraphs 109 to 112.
(8) Martin, paragraph 110.
(9) Martin, paragraphs 113 to 115.
(10) Martin, paragraphs 116 to 120.
(11) Martin, paragraph 122.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.