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Typically, restrictive covenants (non-competition or non-solicitation clauses) are utilized in contracts of employment or contracts involving the sale of a business in order to protect its goodwill and limit a former employee’s ability to compete with his or her former employer or business.

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In Martin v. ConCreate USL Ltd. Partnership, 2013 ONCA 72, 2013 CarswellOnt 1178 (Ont. C.A.), two such clauses, negotiated by two sophisticated, and well-represented parties, were deemed unenforceable by the Ontario Court of Appeal because they contained no fixed outside time limit.

 

Background

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In a rather complex transaction, Derek Martin sold his interest in a concrete business and continued on as its president. In doing so, Mr. Martin signed multiple agreements concerning the sale of his interest as well as his continued employment, both containing similar non-competition and non-solicitation covenants. Upon the completion of the transaction, Mr. Martin still possessed a number of limited partnership units in the Defendant, TriWest Construction Ltd. Partnership.

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Given the Units, the restrictive term imposed was 24 months, and it began to run after the disposition of his direct or indirect ownership interests in the company. The problem, however, was that his ability to dispose of his interest was largely restricted by the Partnership Agreement and the consent of multiple parties. For example, any transfer of the Units was subject to any required consents of the “Lenders”, which is defined in s. 1.1 of the Partnership Agreement to include the respondents’ and their subsidiaries’, senior secured lenders and bonding companies from time to time.

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Six months after the sale transaction, Mr. Martin’s employment was terminated. Almost immediately, Mr. Martin began competing with the defendants, and employed a number of their former employees. The precise situation ConCreate sought to prevent had occurred. A summary and analysis of the relevant aspects of case follows.

 

Restrictive Covenants Revisited: The Test

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Generally, as the Honourable Hoy J.A, writing for the Ontario Court of Appeal surmised [at paras. 49-54]:

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Covenants in restraint of trade are contrary to public policy because they interfere with individual liberty and the exercise of trade: see Elsley v. J.G. Collins Ins. Agencies Ltd., [1978] 2 S.C.R. 916, at p. 923. They are prima facie unenforceable. A covenant will only be upheld if it is reasonable in reference to the interests of the parties concerned and the interests of the public in discouraging restraints on trade: see Elsley, at p. 923.

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The party that seeks to enforce a restrictive covenant has the onus of demonstrating that the covenants are reasonable as between the parties. The party seeking to avoid enforcement of the covenant bears the onus of demonstrating that it is not reasonable with respect to the public interest: see Stephens v. Gulf Oil Canada Ltd. (1975), 11 O.R. (2d) 129 (C.A.), at p. 141.

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If a covenant is ambiguous, in the sense that what is prohibited is not clear as to activity, time, or geography, it is not possible to demonstrate that it is reasonable: see Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6, [2009] 1 S.C.R. 157, at paras. 27, 43; Mason, at para. 14. It is therefore unreasonable and unenforceable.

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The law distinguishes between a restrictive covenant in connection with the sale of a business, and one between an employer and an employee: see Elsley, at p. 924. The former may be required to protect the goodwill sold to the purchaser, and does not usually involve the imbalance of power that exists between employer and employee. Accordingly, a less rigorous test is applied in determining the reasonableness of a restrictive covenant given in connection with the sale of a business: see Shafron, at para. 23; Elsley, at p. 924.

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Greater deference is given to the freedom of contract of “knowledgeable persons of equal bargaining power”: Elsley, at p. 923. Nevertheless, the broader restraints on trade justifiable in the context of a sale of a business must be reasonable within such a context . . .

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The factors relevant in determining whether a restrictive covenant is reasonable are the same in the contexts of the sale of a business and an employment agreement: the geographic coverage of the covenant, the period of time that it is in effect and the extent of the activity prohibited: see Shafron, at para. 43. And, as the application judge noted, reasonableness is determined in light of the circumstances existing at the time that the covenant was made. Those circumstances include the reasonable expectations of the parties about the future activities and marketplace of the business: see Tank Lining Co. v. Dunlop Industrial Ltd. (1982), 40 O.R. (2d) 219 (C.A.), p. 226.

 

Mr. Martin’s Contract: The Application

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With regard to the duration/term of the clauses, the Court of Appeal diverged from the application judge, finding that it was unreasonable and lacked the necessary certainty and clarity [at para. 59]:

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In my view, the duration is unreasonable because it depends on any required consents of third parties, is therefore for an indeterminate period, and there is no fixed, outside limit. Notably, the required consents are not limited to third parties whose consent was required at the time that the covenants were entered into. As the definition of “Lenders” in s. 1.1 of the Partnership Agreement, and the definitions incorporated therein, make clear, the duration is potentially tied to the consent of unascertainable future third parties:

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Hoy J.A. was troubled by the fact that the duration was tied to the period during which Mr. Martin had an indirect interest in the Units. Unlike the usual non-competition covenant obtained in a sale transaction, the duration was not to be calculated from the time of the sale transaction. Nor did it run until a specified time period after Mr. Martin ceased to be an officer or director, as is common in an employment context.

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ConCreate did try to argue that tying the time period to the ownership of the Units was justified, as the ownership of the Units may have allowed the Plaintiff to look at the company’s internal documentation, which would in turn provide a considerable advantage and allow him to compete unfairly. However, this argument was not accepted. This was based in part on the fact that Section 2.3 of the agreements had a strict prohibition against the use of non-public information, which remained in force so long as it carried on business. The Court of Appeal, as in other restrictive covenant cases, determined that what is reasonable will be impacted by the availability of other less restrictive clauses which would sufficiently protect the business.

 

Conclusion

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While each inquiry to determine the reasonableness of a restrictive covenant is fact specific, this case serves as a reminder that the temporal and geographic scope, among other aspects, of the clause need to be unambiguous and not overly broad. Parties should think twice about tying the clauses in their contracts to ambiguous events or persons that cannot be identified or ascertained.

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In addition, before drafting a contract, parties should determine if less restrictive clauses will adequately protect their legitimate business interests. If a non-solicitation clause or confidentiality clause will protect you, a non-competition clause and its rationale may very well be viewed as unreasonable. The problem, however, with restrictive covenants and being able to predict their enforceability, is that they are analyzed within their own unique context and the law in this area is very fluid.

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As this case also demonstrates, even in sophisticated transactions, one cannot simply rely on another party’s equal bargaining power or representation by legal counsel as an iron clad argument to overcome any apparent unreasonableness.

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If you have a employment or labour law issue relating to a restrictive covenant such as a non competition or non solicitation clause, call a top Toronto employment lawyer, Toronto labour lawyer and Toronto human rights lawyer at Stitz Litigation. We are an employment and labour law firm in Toronto with winning experience. Call for a free case assessment.