Canada: The HR Space: Non-Compete Agreement In Purchase And Sale Or Employment Agreement?

Last Updated: February 28 2012
Article by Chris Semerjian

When employers are buying other businesses, the question of non-competes often arises. But a non-competition provision in an employment contract may not be the answer. According to the Quebec Court of Appeal in Guay Inc. c. Payette (PDF - only available in French), you may be better protected by only having a non-competition covenant in your sales agreement rather than also including such a clause in your new employees' employment contracts.

Factual Background

In October 2004, Guay Inc. bought the assets of the company controlled by Payette for $26 million. Pursuant to the purchase and sale agreement, Payette was hired as a consultant for a period of six months. The purchase and sale agreement also included a non-competition clause prohibiting Payette from competing with Guay in Quebec for a period of five years after his employment relationship ended.

Six months later, Payette was hired by Guay as a director. His employment contract with Guay did not include a non-competition clause.

In August 2008, Guay terminated Payette's employment. In March 2010, Payette was hired by one of Guay's competitors, where he was followed by seven of Guay's employees.

Guay asked the Superior Court of Quebec to issue an interlocutory injunction preventing Payette from joining the ranks of its competitor. The outcome of the case depended on the nature of the non-competition agreement.

Employment vs. Sales Agreement

There are important distinctions between a non-competition agreement found in an employment contract and one found in a purchase and sale agreement.

The first distinction, at least in Quebec, is that the provisions of the Civil Code of Quebec governing employment contracts do not apply to sales agreements. As such, section 2095 of the Code, which prohibits an employer from benefiting from a non-competition clause if it terminates the employment contract without a serious reason, does not apply. Section 2089 of the Code, which imposes on the employer the burden of proving that the non-competition is valid, will also not apply to a sales agreement.

The second and more general distinction derives from the imbalance that exists in an employer-employee relationship which is not usually found in the buyer-seller relationship. Although to be valid both types of non-competition agreements need to be limited in time, in space, and in the restricted activities, courts show more latitude when the restrictions are contained in a purchase and sale agreement.

Part of an Employment Contract?

In Guay, the Superior Court said that the parties had the intention to create an employment contract in the purchase and sale agreement. As such, the non-competition covenant was in fact part of an employment contract. Because Payette's employment was terminated without cause, the trial judge ruled that Guay could not claim the protection of the non-competition agreement which, in any event, contained limits that were too broad for an employment contract.

Or Part of a Sales Agreement?

The case then proceeded to the Quebec Court of Appeal. It said that one must determine the reason that motivated the parties to enter into a non-competition agreement. A non-compete clause would either have to fall under the regime governing purchase and sale agreements or under the regime governing employment contracts.

In the case at hand, the Court of Appeal determined that the real reason behind the non-competition clause was the purchase and sale agreement. Indeed, Guay's real interest in prohibiting Payette from competing did not stem from Payette's employment, but rather from the $26 million investment made by Guay as part of the purchase and sale agreement. Further, the fact that Payette's employment contract did not contain a non-competition agreement was a clear indication that the motivation behind the non-competition agreement was the sales agreement.

In the end, the Court of Appeal overruled the trial judge and ruled that the non-compete clause was valid. Payette is now seeking to appeal to the Supreme Court of Canada.

Recommendations to Employers

If the Supreme Court of Canada agrees with the Court of Appeal, employers that wish to acquire a competitor's business and employees may be better protected with only a non-competition clause in the purchase and sale agreement, rather than by adding another non-compete clause in an employment contract. Given the similarity of case law pertaining to non-competition clauses across the country, this decision might also affect companies looking to acquire a competitor located outside Quebec.

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.

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