As an employer, rather than including a conventional non-competition clause in an employment agreement, how about including a clause that does not prohibit competition, but requires the employee to pay a set amount in the event that he or she competes following termination?
The British Columbia Court of Appeal recently considered this type of clause in an employment agreement and gave the employer’s drafting strategy its approval: Rhebergen v. Creston Veterinary Clinic Ltd., 2014 BCCA 97(“Rhebergen”).
In this case, the employee was a veterinarian and the employer was a veterinary clinic. Given the significant cost involved in training the employee, the parties agreed to a compensation clause in the employment agreement. The clause would be triggered if the employee were to leave employment with the clinic and set up a competing business during the three-year period following the termination of her employment. However, the clause did not prohibit the employee from actually competing. The relevant portion of the clause read as follows:
The Associate [the employee] covenants and agrees that in consideration of the investment in her training and the transfer of goodwill by CVC [the employer], if at the termination of this contract with CVC she sets up a veterinary practice in Creston, BC or within a twenty-five (25) mile radius in British Columbia of CVC’s place of business in Creston, BC, she will pay CVC the following amounts:
- If her practice is set up within one (1) year termination of this contract - $150,000.00;
- If her practice is set up within two (2) years termination of this contract - $120,000.00;
- If her practice is set up within three (3) years termination of this contract - $90,000.00.
Fourteen months after commencing employment, the employee sought to leave the clinic and the employment agreement was terminated. Five months after that, she announced her intention to set up a mobile veterinary practice in the local area. She then applied to the court to have the compensation clause in her employment agreement declared unenforceable.
The Court’s Decision
At trial, the judge found that the compensation clause was a restraint of trade and unenforceable. In the judge’s view, the clause was unreasonable because it was ambiguous and because it imposed a penalty on the employee.
On appeal to the British Columbia Court of Appeal, the panel of judges hearing the appeal all agreed that the compensation clause was a restraint of trade. However, they disagreed with the trial judge that the clause amounted to a penalty. Instead, they characterized the clause as one seeking compensation for the costs incurred by the clinic in training the employee. While the juges were divided on whether the clause was ambiguous, the majority concluded that the clause was not ambiuous. Accordingly, the majority of the Court of Appeal found that the clause was reasonable and enforceable against the employee.
The Take Away for Employers
A compensation clause in an employment agreement similar to that in the Rhebergen case may make sense for both the employer and the employee in some circumstances - where, for instance, the potential employee will not agree to an express prohibition on competing post-employment.
If an employer chooses to include a compensation clause in an employment agreement, care must be taken in drafting the clause to ensure that it is reasonable and, therefore, likely to be enforceable. To be reasonable, the clause must:
- protect a legitimate proprietary interest of the employer;
- be reasonable between the parties in terms of:
- temporal length;
- spatial area covered;
- nature of activities prohibited; and
- overall fairness;
- have clear, certain, and not vague terms relating to the restraint;
- be reasonable in terms of the public interest with the onus on the party seeking to strike out the restraint.
In addition, the prescribed monetary amount(s) set out in the clause should be based on objective evidence. In Rhebergen, the employer calculated the amounts based on its cost to mentor, train and provide equipment to the employee, along with an analysis of the impact on its goodwill and volume of business if the employee were to leave and compete for its clientele. Using this analysis, the employer established monetary amounts that decreased over time, depending on how soon after the termination of employment the employee’s competition commenced.
The inclusion of a compensation clause in an employment agreement in lieu of a traditional non-competition clause will require an employer to engage in upfront efforts to calculate its possible economic loss if the employee departs and chooses to compete. However, if drafted properly and used in the right situations, such efforts can provide significant financial protection for the employer in the event the employee later competes.