Canada: Even Transactional Employment Covenants Need Careful Review

Last Updated: March 12 2013
Article by George Waggott and Joshua Chad

The continued scrutiny by Canadian courts of post-employment covenants is confirmed in a recent decision from the Ontario Court of Appeal. In Martin v ConCreate,1 the Court held certain non-competition and non-solicitation covenants that arose in the context of the sale of a business to be unenforceable as their duration could extend indefinitely. Perhaps most troubling for employers and transaction lawyers is that the Court permitted the restrictive covenants to be challenged as unreasonable even in the face of the executive having received legal advice and having agreed that the restrictive covenants were reasonable at the time they were negotiated.

Key facts

While employed at ConCreate USL Ltd., Derek Martin had acquired a minority interest in the company and in a related business, Steel Designed & Fabricators (SDF) Ltd. ("SDF"). ConCreate USL Limited Partnership ("ConCreate"), a limited partnership controlled by TriWest Construction Limited Partnership ("TriWest LP"), purchased ConCreate USL Ltd. and SDF. In connection with the sale, Martin's holding company received a 25 per cent interest in TriWest LP, giving Martin an indirect interest in ConCreate and SDF. Martin was appointed president of ConCreate and SDF and signed restrictive covenants in favour of ConCreate and SDF, including a non-competition clause and a non-solicitation clause.

The terms of the non-competition and non-solicitation covenants were to end 24 months after Martin disposed of his indirect interest in TriWest LP. However, in order to dispose of the interest, Martin required the consents of the lenders of ConCreate, SDF, and their subsidiaries, whoever they might be "from time to time."

Within six months of the closing of the sale transaction, Martin's employment was terminated for cause. Eight days later, Martin started a competing company employing former ConCreate employees and managers. ConCreate and SDF started an action against Martin to enforce the restrictive covenants.

The court's ability to scrutinize the restrictive covenants

The Court acknowledged that the restrictive covenants arose in the context of the sale of a business, and thus a less rigorous test was to be applied than would have been the case had the restrictive covenants arisen out of an employment relationship. Moreover, the Court acknowledged that, at the time the agreements were signed, Martin had agreed that the covenants were reasonable, and Martin had the benefit of legal counsel. However, the Court maintained that, while all of these factors were important, they did not immunize the restrictive covenants from scrutiny. The Court held that its duty in safeguarding the public interest in free and open competition demanded that the Court conduct a deeper analysis of the restrictions.

Indeterminate duration of the covenants unreasonable

The Court held that the non-competition and non-solicitation covenants were unreasonable, and thus unenforceable, as their duration was not determinable. The duration of the covenants depended on the consents of third parties, those being the lenders "from time to time." This created an indeterminate obligation with no fixed or outside limit provided. The Court highlighted that these third parties owed no contractual duty to Martin to act promptly or reasonably. Furthermore, the third-party lenders had a commercial interest in limiting Martin's competition with ConCreate and SDF, and, thus, the lenders would be incentivized to withhold consent. The result was an overly broad set of restrictions with no guaranteed upper limit.

Overbroad prohibited activities in the covenants unreasonable

Although the Court's decision in favour of Martin rested on the indeterminate duration of the covenants being unreasonable, the Court also stated that it believed that the scope of the prohibited activities in the restrictive covenants was also unreasonable. The Court explained that Martin had no basis to know what new customers had begun to engage in business with SDF and ConCreate after he left. Thus, Martin had no way of knowing who he was not allowed to solicit. Furthermore, the Court explained that Martin could not be expected to know about every new product or service that SDF and ConCreate would start offering or plan to start offering after his departure.

Drafting restrictive covenants going forward

In drafting employment agreements, restrictive covenants or related transaction documents, employers should keep in mind that restrictive covenants must be reasonable at the time they are made, and they must be reasonable in light of the public interest in discouraging restraints on trade. Where restrictive covenants are not reasonable, they are not enforceable. Careful consideration must be given to the duration and scope of prohibited activities in restrictive covenants to ensure that their terms are reasonable. For duration, the term of a restrictive covenant should not rely on the consent of a third party. There should also be a specific upper limit to the duration that does not rely on an indeterminable event. In drafting the scope of prohibited activities, an effort should be made to ensure that the departing employee can readily ascertain what actions are prohibited and that these prohibitions are reasonable. If there is potential uncertainty as to what the employee can and cannot do, the restrictive covenant is at risk of being held to be unreasonable and thus unenforceable.

Footnotes

1. Martin v ConCreate USL Limited Partnership

The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.

© Copyright 2013 McMillan LLP

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Authors
George Waggott
Joshua Chad
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