Canada: Restrictive Covenants: In Sale Transactions vs. Employment Agreements

Introduction

The Supreme Court of Canada succinctly has answered the question that has plagued transaction lawyers and their clients for some time: can restrictive covenants in the context of a sale transaction be broader than in an employment agreement context?

Summary

In the well-reasoned judgment of Yannick Payette et al. and Guay inc.ⁱ the Supreme Court of Canada stated as follows:

1. Different rules are applied to restrictive covenants relating to employment when the covenants are linked to a sale of a business as opposed to a contract of employment. This is largely due to the nature of the relationship and the assumption that the parties negotiating a sale transaction are on a more equal playing field, whereas employees do not have the same freedom to contract.

2. It is necessary to determine the reason for the restrictive covenant. A non-competition covenant will be found to be reasonable and lawful when limited as to term and territory, if required to protect the interests of the seller of the business.

3. For a non-solicitation covenant to be upheld, if it is reasonable, it need not have a territorial limitation to be lawful, if the seller's customers can be identified.

Facts

a. Yannick Payette ("Payette") and his partner controlled a number of companies in the province of Quebec in the crane rental business. Guay inc. ("Guay") is a crane rental company. In October 2004, Guay purchased, for 26 million dollars, the assets of the companies controlled by Payette and his partner.

b. In the agreement of sale (the "October Agreement") Payette and his partner agreed to consult full time for the purchaser for six (6) months. The October Agreement also provided for a subsequent employment agreement contract for Payette and his partner.

c. The October Agreement contained both a non-competition provision as well as a non-solicitation clause. The non-competition provision essentially stated that "in consideration of the sale"...Payette "covenants and agrees for a period of five (5) years from the Closing date" or in the case of Payette and his partner, "for a period of five (5) years from the date" on which he ceases to be employed, not to be involved in the crane rental industry in the province of Quebec.

d. The non-solicitation clause was for a similar time period. However it referred to solicitation of customers of the crane rental business, in any place whatsoever and to non-solicitation of employees of the business, save for those who resigned or were dismissed.

e. At the end of the six (6) month consultation period, Payette and Guay signed a separate employment contract which was to terminate on August 31, 2008, but which was renewed thereafter for an unspecified term. In August 2009 Payette was terminated without cause.

f. In March 2010 Payette commenced work with a competitor of Guay. The same month seven (7) employees went to this competitor.

Lower Court Decision

In April 2010, Guay filed for an interlocutory injunction in Quebec Superior Court asking the court to enforce the provisions of the October Agreement. The injunction was granted and renewed until the action was heard and dismissed. The Superior Court relied on an employment provision in the Quebec Civil Code and determined that Guay could not rely on the non-competition and non-solicitation clauses as it had dismissed Payette without cause. In addition, the non-competition clause was unlawful because it was too broad; the non-solicitation provision was unlawful because it did not limit the territory or activities.

Court of Appeal Decision

The majority of the Quebec Court of Appeal set aside the decision of the lower court and ordered a permanent injunction, requiring Payette to comply with both the non-competition provision and the non-solicitation provision of the October Agreement. Most notably, the majority determined that the restrictive covenants were not part of the employment contract, since their purpose was to protect the investment made by Guay when it purchased the assets under the October Agreement. As well, the Court of Appeal found that the two provisions were reasonable and lawful.

Supreme Court of Canada Analysis

1. As noted, the rules are different when considering restrictive covenants in contracts for the sale of a business as opposed to contracts of employment. Generally the rationale is the difference in bargaining power of the parties. Preventing a seller from competing with the purchaser enables the purchaser to protect its investment in the business it has purchased. The provision of the Quebec Civil Code relied upon by the lower court is only applicable if the clause is linked to a contract of employment. To determine the linking of the covenant, it is necessary to analyze the nature of the obligations and determine their purpose. In this instance, the restrictive covenants could not be disassociated from the sale of the assets. The initial language of the covenants refers to "in consideration of the sale."

2. When determining whether a non-competition covenant is reasonable and lawful, it needs to be limited as to its term and to the territory and activities to which it applies, in the context of what is necessary to protect the interests of the party in whose favour it is made. There are many factors to be considered, including the price, the activities, the parties' experience and expertise and whether they are represented by counsel. In respect of term, the restriction must be limited in time or it will be contrary to public order. The SCC determined that each case must be assessed; in this situation, the highly specialized nature of the business merited the five (5) year period.

3. In respect of geographic or territorial scope, a non-competition clause should be limited to that in which the business was carried on as of the date of the transaction. A non-competition clause that applies outside the territory in which the business operates, generally, is contrary to public order. Since the crane rental business is mobile and goes where the construction sites are located, and since Payette stated that not all the activities of his business were in Montreal, the territory of Quebec was not broader than necessary to protect the business interests of Guay.

4. The SCC determined that the non-solicitation covenant was reasonable and not unlawful even though it did not contain a territorial limitation. The object of a non-solicitation clause is narrower than the object of a non-competition clause. Generally the obligations are also less strict. "In the context of the modern economy, and in particular of new technologies, customers are no longer limited geographically, which means that territorial limitations in non-solicitation clauses have generally become obsolete."

Conclusion

Restrictive covenants in sale transactions will be afforded a more generous interpretation than those in employment contracts. The circumstances of the parties to the commercial transaction are to be considered when determining restrictive covenants in agreements of sale in contrast to those in employment contracts. It would therefore be prudent to ensure that these covenants be placed in the commercial agreement and not left to an employment or consulting agreement with the seller or its principal. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.