The Supreme Court of Canada recently handed down a decision in Shafron v. KRG Insurance Brokers (Western) Inc.1 in which it re-examined the issue of non-competition and non-solicitation restrictive covenants in an employment contract. The Shafron decision highlights how narrowly Canadian courts will interpret and apply restrictive covenants in employment contracts. The Supreme Court has reinforced the Canadian view that a restrictive covenant is prima facie a restraint on trade and that only restrictive covenants that are reasonable (i.e., limited and directly tied to a demonstrable economic concern) and unambiguous will be enforced.
In 1987, Morley Shafron sold his insurance agency to a company which was renamed KRG Insurance Brokers (Western) Inc. Shafron continued to be employed by KRG Western after the sale pursuant to a series of employment contracts. All of the employment contracts included essentially the same non-competition clause. The clause prohibited Shafron from competing in any way with KRG Western within the “Metropolitan City of Vancouver” for a three-year period.
In December 2000, as his most current employment contract was set to expire, Shafron resigned from KRG Western and, in January 2001, began working as an insurance salesman for an agency located in Richmond, British Columbia that was a competitor of KRG Western. While Richmond is generally agreed to be a suburb of Vancouver, it is not part of the “City of Vancouver”. KRG Western commenced an action against Shafron in the British Columbia Supreme Court alleging that Shafron had breached his non-competition clause when he began to work for a competitor in “Metropolitan Vancouver” and was in breach of his fiduciary obligations to KRG Western not to use confidential information or solicit KRG Western’s clients. While the trial judge dismissed the action commenced by KRG Western, the British Columbia Court of Appeal enforced the terms of the restrictive covenant. This decision has now been overturned by the Supreme Court.
THE SUPREME COURT OF CANADA DECISION
The Supreme Court found that the restrictive covenant was not enforceable because the term “Metropolitan City of Vancouver” was ambiguous. This ambiguity could neither be explained by the mutual intent of the parties regarding the geographic scope of the covenant nor resolved through severance or rectification by the court.
The Supreme Court considered whether it could “blue pencil” the employment contract (i.e., sever the term) in order to “save” the clause or apply some portion of the remaining restrictive language to allow the employer to retain some of what it had contracted for – that is, maintain some limitation on the post-employment rights of the employee.
The Supreme Court stated that blue-pencil severance should only be resorted to where the part of the employment contract being removed is clearly (a) severable, (b) trivial, and (c) not part of the main purport of the restrictive covenant. In addition, the Supreme Court found that there must be evidence that the parties would have unquestionably agreed to the change. In this case, the Supreme Court held that there was no evidence that the parties would have unquestionably agreed to remove the word “Metropolitan” without varying any other terms of the contract. Consequently, the whole restrictive covenant was deemed to fail.
The Supreme Court further found that notional severance should never be applied to restrictive covenants in employment contracts for two reasons. First, there is no bright-line rule that can be applied to render a restrictive covenant in an employment contract reasonable as there may be with other types of contracts. Second, the Supreme Court reasoned that to allow notional severance to be used to read down employment contracts would invite employers to draft unreasonably broad restrictive covenants, and leave it to the courts to decide what should be “saved”. This would provide no inducement to employers to ensure the reasonableness of restrictive covenants and would increase the risk that employees would be forced to abide by an unreasonable covenant or proceed with an action.
Finally, the Supreme Court stated that contract rectification will only be applied to resolve an ambiguity in a restrictive covenant if: (a) an inconsistent prior oral agreement existed and its content was known, (b) allowing the difference between the written contract and the oral agreement to stand would amount to fraud or the equivalent of fraud, and (c) “the precise form” in which the written instruments could be made to express the prior intention is shown. Given that there was no prior agreement between Shafron and KRG Western that explained the term “Metropolitan City of Vancouver”, the Supreme Court concluded that rectification could not be used to resolve the ambiguity of the restrictive covenant in this case.
The principal lessons that employers should take from the Shafron decision are the following:
- restrictive covenants will be considered unreasonable if they include an ambiguous term;
- an ambiguous term in a restrictive covenant cannot be severed from the rest of the employment contract to make the clause reasonable as doing so may render the whole clause void;
- only in rare cases will the court rectify language in an employment contract to resolve an ambiguity in a restrictive covenant, but clear prior written evidence of the alternate wording will likely be required (i.e., the court will fix a clear mistake, but not much else); and
- employers must ensure when drafting restrictive covenants that the terms are reasonable and that the language used is unambiguous. It will be the employer that will suffer the consequences of a failed term.