It is apparent from the number of recent cases involving the use and enforcement of restrictive covenants that the area of law governing restrictive covenants is rapidly developing and, to a large extent, developing in favour of the enforcement of such provisions. As such, potential business acquirors and employers should give careful consideration to including restrictive covenants in employment contracts for key personnel and acquisition agreements.1 This article reviews the traditional approach of courts to enforcing restrictive covenants and the more recent emergence of the doctrine of "notional severance," and offers some suggestions on the use and drafting of restrictive covenants.
Restrictive covenants include both non-competition and non-solicitation clauses. A non-competition clause typically attempts to prevent the seller of a business or an employee from competing with a buyer or its employer within a certain geographic area for a certain period of time. A non-solicitation clause is less restrictive as it typically aims to preclude a party from actively soliciting customers, clients or other employees of the business.
Traditionally, courts have been reluctant to enforce such covenants particularly in the context of employment agreements.2 The British Columbia Supreme Court (the "BCSC") provided the following guidance on such covenants:3
- The employer has the onus of establishing that the covenant is reasonable and the employee has the onus of establishing that the covenant is contrary to public policy.
- Restrictive covenants in an employment contract are scrutinized more rigorously than restrictive covenants in an agreement for the sale of a business.
- A restrictive covenant that restricts competition generally, rather than what is reasonably required for the protection of the employer, will generally be unenforceable.
- A restrictive covenant will only be enforceable if it is reasonable between the parties and with reference to the public interest.
- Public interest encourages free and open competition and discourages restraints on trade.
Courts have tried to balance the competing interests of discouraging restraints of trade and maintaining free and open competition unencumbered by the fetters of restrictive covenants, on the one hand, while at the same time respecting the right of parties to contract, particularly where there is equal bargaining power. In doing so, courts have generally required the party seeking to uphold a post-employment restrictive covenant to prove that the restraint has the following characteristics:
(a) it protects a legitimate proprietary interest of the employer;
(b) it is reasonable between the parties in terms of:
(i) temporal length;
(ii) spatial area covered;
(iii) nature of activities prohibited; and
(iv) overall fairness;
(c) its terms are clear, certain and not vague; and
(d) it is reasonable in terms of the public interest with the onus on the party seeking to strike out the restraint.
The British Columbia Court of Appeal ("BCCA") has also suggested that non-competition clauses will rarely be enforced where a non-solicitation clause will suffice to protect the otherwise legitimate proprietary interest of the employer. In such cases, the non-competition covenant will be unnecessary, unreasonable and therefore unenforceable. It is only when a non-solicitation covenant cannot adequately protect the employer's established legitimate proprietary interest that a non-competition covenant will be enforceable.
"Notional Severance" – The Rewriting of Restrictive Covenants
In Elsley, the Supreme Court of Canada (the "SCC") noted that restrictive covenants must be considered in the terms actually drafted, not in terms of how they might have been validly drafted. The SCC stated that:
In a conventional employer/employee situation the clause might well be held invalid for that reason [unenforceable as being against competition generally]. The fact that it could have been drafted in narrower terms could not have saved it, for as Viscount Haldane said in Mason v. Provident Clothing and Supply Company supra, p. 732, '... the question is not whether they could have made a valid agreement but whether the agreement actually made was valid.'
Notwithstanding this strict approach, courts began to "rewrite" restrictive covenants that were otherwise void by applying the "blue pencil test," which has resulted in some inconsistent decisions.
Liberal though the blue pencil test may seem, the SCC went one step further in Transport North American Express Inc. v. New Solutions Financial Corp., when it developed and endorsed the doctrine of notional severance. That case concerned a credit agreement which contained an interest component that contravened the criminal interest provision of the Criminal Code. The SCC was critical of the blue pencil approach applied by the Ontario Court of Appeal in this case, and instead adopted the broad concept of "notional severance." This concept creates a spectrum of possible remedies and vests the courts "with the greatest possible amount of remedial discretion in judges in courts of first instance."
Armed with this new found power, British Columbia courts have frequently applied the notional severance concept to, in essence, rewrite restrictive covenants to ensure their enforceability. One recent example shows how far the concept of notional severance has developed. In KRG Insurance Brokers (Western) Inc. v. Shafron, the restrictive covenant precluded the employee/vendor from competing in the insurance brokerage business for a period of three years following termination "within the Metropolitan City of Vancouver." The vendor sold his insurance agency and continued as an employee, signing successive employment covenants that incorporated the non-competition clause in question. The issue with the clause in question was the use of the word "Metropolitan" in reference to Vancouver, as there was at that time, simply no "fixed, recognized meaning" to that phrase. The BCCA noted that the clause was drafted by lawyers in Toronto for whom the expression "Metropolitan" does have clear meaning. By applying notional severance, the Court saved the bargain and construed "Metropolitan City of Vancouver" to mean "the City of Vancouver, the University of British Columbia Endowment Lands, Richmond and Burnaby, as they are organized under provincial law." What is somewhat remarkable is the Court's conclusion that "the terms of the covenant are clear, certain and not vague in that there is no doubt that the parties intended to prevent Mr. Shafron from competing in the City of Vancouver and an area beyond the City" and therefore "a reasonable construction of the word 'Metropolitan'" was possible.
Notional severance has not been restricted by British Columbia courts to covenants that emanate from purchase and sale agreements. In Jones v. Prostar Painting and Restoration Ltd., the BCSC rewrote a non-competition clause in an employment contract by substituting a two-year restriction for the five-year restriction that had been agreed to by the parties. In rewriting the restrictive covenant, the Court provided little analysis as to why a two-year restriction was reasonable, which is somewhat troubling given that the employee was a salesman and not a member of senior management. Further, there appeared to be little evidence that the painting business was probably competitive or that the employer had overcome the heavy onus on it to prove the reasonableness of even the less onerous amended provision. Finally, there was no discussion of why the non-solicitation clause in the contract was insufficient to protect the employer's interests.
Courts have been active in considering the enforceability of restrictive covenants. Recent cases demonstrate the broad spectrum of the types of issues that are currently before the courts. The overall trend of these cases appears to be in favour of enforcing such restrictions even where that requires the court to rewrite the covenant. However, the application of notional severance to save restrictive covenants is far from universal and therefore it might take a SCC decision to provide clarity and guidance in this area.
Although non-competition and non-solicitation covenants might not enjoy the same favourable tax treatment they once had, they do serve a very useful purpose in protecting the interests of potential business purchasers, vendors and employers. They may increase the value of the business to the vendor if the purchaser is not subject to unfair competition from the vendor for a reasonable period of time. A well-drafted restrictive covenant of course also provides value for the purchaser, who would have the ability to rely upon it. As the SCC stated in Elsley:
The distinction made between restrictive covenants contained in an agreement for the sale of a business and one contained in a contract of employment is well conceived and responsive to practical considerations. A person seeking to sell his business might find himself with an unsaleable commodity if denied the right to assure the purchaser that he, the vendor, would not later enter into competition.
In light of the trend toward notional severance, parties may find they are tempted to pay little attention to the drafting of proper restrictive covenants in the hope that a court will simply rewrite the covenants if they are found to be unreasonable. We do not think this is a wise approach. As noted, some courts are at odds regarding the appropriateness of notional severance for the purposes of saving restrictive covenants, especially in the employment context. Notional severance appears to be directly contrary to the edict of the SCC in Elsley. As the Alberta Court of Appeal stated in Globex Foreign Exchange Corp. v. Kelcher, "employers should not be permitted to draft unreasonably broad restrictive covenants with the expectation that, should the matter ever come to trial, the court will simply re-write the clause so as to make it enforceable." Until the SCC definitively rules on this issue there are inherent risks involved in relying on notional severance.
Parties should continue to adopt a careful and conservative approach in drafting these provisions. These clauses should be drafted only after careful consideration of the business and interests of the purchaser and/or employer that need to be protected. Parties might consider drafting these provisions with a view to relying on the same information they would need to include in an affidavit in support of their argument to enforce the covenant. In light of the judicial trend discussed above, we also suggest that, in most cases, a non- competition clause be included along with a non-solicitation clause (even if a non-solicitation clause might suffice), and that the contract contain a severability clause. Finally, parties may want to consider including a clause, similar to that found in the contract in Prostar, giving the courts explicit authority to apply the concept of notional severance.
Certainty of contract remains important. Well-drafted restrictive covenants can serve a useful purpose in any business acquisition, commercial or employment agreement. It can enhance and protect the value of any business. Accordingly, care should be taken in drafting these provisions and parties should resist the temptation to rely on the nebulous concept of notional severance to save the bargain.