The departure of a key employee to join a competitor is one of the most highly charged and emotional situations faced by an employer, especially where there is a tug of war with the former employee over customers and business opportunities. To combat this problem, many employers will include restrictive covenants in employment agreements with their executives and other key employees to protect their business interests.
But the Supreme Court of Canada recently issued a cautionary note to employers that implement restrictive covenants that are not clear or are unreasonable. In the Shafron v. KRG Insurance Brokers (Western) Inc. decision, the Court considered whether the doctrine of severance could be invoked to either resolve an ambiguous term in a restrictive covenant or fix an unreasonable restrictive covenant.
Unfortunately for employers, the Supreme Court of Canada confirmed that when faced with a restrictive covenant that is ambiguous or over-reaching, the proper remedy is to strike it down. The Court concluded that notional severance (which means "reading down" a contractual provision to make it legal and enforceable) is not an appropriate mechanism to cure a defective restrictive covenant. It also found that blue pencil severance (which means removing part of a contractual provision) could only be used in exceptional circumstances.
Mr. Shafron sold his insurance brokerage to KRG in 1987, but remained employed in the business. Shafron did not agree to any restrictive covenants as part of his sale of business agreement with KRG. However, Shafron subsequently entered into a series of employment agreements with KRG in which he agreed that he would not be employed in any insurance brokerage within the "Metropolitan City of Vancouver" for a period of three years after leaving his employment for any reason other than termination without cause. Although another entity acquired the shares of KRG in 1991, the restrictive covenant in Shafron’s employment agreement remained essentially identical.
In 2001, Shafron left KRG to join another insurance brokerage in Richmond, British Columbia. KRG commenced an action to enforce the restrictive covenant. The trial judge dismissed the action in part because the geographic restriction was ambiguous and unclear. However, the BC Court of Appeal overturned the lower court's decision, and enforced the restrictive covenant. The BC Court of Appeal agreed that the term "Metropolitan City of Vancouver" was ambiguous; however, it argued that this term could be construed to mean "the City of Vancouver, the University of British Columbia endowment land, Richmond and Burnaby."
The Supreme Court of Canada unanimously found that the BC Court of Appeal erred by re-writing the geographic restriction in Shafron’s employment agreement. It stated that courts should not assist employers seeking to rely upon vague or ambiguous restrictive covenants in employment agreements by reading down or re-writing language into something that could be enforceable. The Court also expressed concern that applying notional severance would invite employers to draft over-broad restrictive covenants in employment agreements.
It held that a court should not re-write a vague or over-reaching covenant to reflect its own view of what would be reasonable in the circumstances or what the parties originally wanted. The Court reaffirmed that the proper remedy is generally to declare the ambiguous restrictive covenant to be void and unenforceable. However, the Court did allow that a decision-maker could, in very limited circumstances, "blue pencil" or remove wording in an employment agreement that is "clearly severable, trivial and not part of the main purport of the restrictive covenant."
The Supreme Court of Canada did draw a distinction between restrictive covenants that are negotiated as a term and condition of employment, and those that are included as part of a sale of business agreement. Because of the potential power imbalance between employer and employee, the Court recognized that restrictive covenants in an employment agreement should receive more rigorous scrutiny. However, a purchaser or employer will be given more latitude by the courts where a restrictive covenant is contained in a sale of business agreement, and the purchaser has compensated the vendor or employee in exchange for his or her promise not to compete.
So what does the Shafron decision mean for employers and for potential purchasers in a business acquisition? First, a purchaser who wants to protect its business interests from the vendor following an acquisition should expressly link those restrictive covenants to the agreement of purchase and sale. Second, an employer must draft clear language when defining the scope of business, geography and time period in a restrictive covenant. Third, the restrictive covenant should be specifically tailored to the business activity, time period and geographic area where the departing employee could harm the employer’s interests.
The courts will continue to recognize a delicate balance between the right of an employer to protect its business, and the right of a departing employee not to be unduly restrained following the termination of employment. However, the Shafron decision re-emphasizes the need for employers to implement clear and well-drafted restrictive covenants when hiring key employees, rather than relying on the courts in response to an untimely and potentially damaging resignation.