Canada: Martin V. ConCreate USL Limited Partnership Update: Court Of Appeal Finds Restrictive Covenants To Be Unenforceable

A decision we discussed in a previous post – which held that certain restrictive covenants signed in the context of a sale of business were enforceable – has been substantially overturned by the Ontario Court of Appeal. In its decision, the Court of Appeal held that the non-competition and non-solicitation covenants were unreasonable because the restrictions went beyond what was required to protect the business. Therefore these covenants were held to be unenforceable. The Court upheld the lower court's decision regarding the confidentiality covenant which was, in the Court's view, reasonable and enforceable.

The non-competition and non-solicitation covenants at issue were included in a limited partnership agreement and an employment agreement (the Agreements) which were both signed by an employee, Derek Martin, in the context of a sale of a business.  As described our previous post, in exchange for his 25% interest in the business being sold, Mr. Martin received, among other things, partnership units in TriWest Construction Limited Partnership (TriWest LP). We note that, although the restrictive covenants were in part contained in an employment agreement, the Court's analysis of the enforceability of the covenants took place in a sale of business context, rather than strictly in the context of an employment relationship.

In its decision, the Court of Appeal undertook a similar analysis to that of the lower court, considering first whether the covenants were ambiguous and then turning to the reasonableness of the covenants. After confirming the lower court's finding that the covenants were sufficiently clear and unambiguous, the Court then considered whether the covenants were reasonable. The reasonableness of the term and geographic scope of the covenants and the activities which the covenants prohibited were each considered in turn.

Geographic Scope

The Court of Appeal confirmed the lower court judge's view that the geographic scope of the covenants was reasonable. The scope included all of Canada, which was acceptable based on the parties' reasonable expectations of the scope of the business at the time of the acquisition.

Term / Prohibited Period

On the question of whether the prohibited period of the covenants (i.e., the term during which Mr. Martin was prohibited from competing or soliciting) was reasonable, the Court of Appeal held that it was not reasonable, because it had "no fixed outside limit". The restricted period was for 24 months, commencing on the date that Mr. Martin disposed of his indirect interest in the TriWest LP units. This was problematic from the Court's perspective because, in order to dispose of his units, consent from certain third parties was needed, including the consent of lenders to the partnership. There was no guarantee that such consent would be forthcoming, especially since these third parties owed no duty to Mr. Martin, and, in fact, had a commercial interest in preventing him from competing with TriWest LP.

Interestingly, the Court also stated that it was "troubled by the fact" that the prohibited period ran from the date he disposed of his units, rather than the date of the sale transaction. However, the Court went on to say that this particular finding was not determinative.

Prohibited Activities

Although the Court decided that the covenants were unenforceable based on its finding that the prohibited period was unreasonable, the Court also gave its view, in obiter, regarding the scope of the activities which Mr. Martin was prohibited from engaging in during the prohibited period.

The scope of the prohibited activities was also found to be overly broad (and therefore unreasonable) because the clause contemplated restricting Mr. Martin from performing activities that were not carried on during his involvement with the business.

In addition, the non-solicitation clause was drafted to include "any product or services that compete with products or services" offered by Mr. Martin's former employer, whether such products were offered or anticipated to be offered at the time of the sale transaction or not. This was viewed as beyond what was required to protect the interests of the business being sold and as such, the covenants were unreasonable. As the Court put it:

"It is not reasonable for a restrictive covenant, given in the context of the sale of a business, to extend to activities neither carried on nor in the parties' contemplation at the time of sale, while the covenantor was involved in the business post-sale, or even while the covenantor had an ownership interest in the business."

We note that the Court took the position that the prohibited period and prohibited activities were not reasonable, despite the fact that the Agreements contained a clause wherein Mr. Martin explicitly acknowledged that the covenants were reasonable and required in order to adequately protect the business. Such provisions, according to the Court, do not "immunize the clause from scrutiny" and a court may undertake a reasonableness analysis of its own notwithstanding such provisions.

Our Views

We reiterate our views as outlined in our previous post on this case: in order to improve the likelihood that a court will enforce a restrictive covenant, the covenant must be drafted as clearly and as narrowly as possible and only go so far as necessary to protect the parties' legitimate business interests. This rule applies whether the covenant is entered into in the context of a sale of business or in the context of an employment relationship. Although the courts will apply the test of whether a restrictive covenant is reasonable less rigorously in the context of a sale of a business, Martin v. ConCreate demonstrates that such covenants must nevertheless still be reasonable. And, as discussed above, an agreement between the parties that the covenants are reasonable will not be determinative of whether a court or a judge will find them to be reasonable.

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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