Canada: Supreme Court Endorses Freedom Of Contract In Finding Commercial Restrictive Covenants Valid

This week's decision from the Supreme Court of Canada (SCC) in the case of Yannick Payette et al. and Guay Inc. has confirmed that restrictive covenants negotiated in the context of a sale of a business must be interpreted using commercial law rules and not the rules applicable to assessing such covenants in the context of employment relationships, even when the covenants apply after employment ends. In the words of the SCC, the rules regarding the assessment of restrictive covenants do not apply with "the same rigour or intensity" where the obligations are assumed in the context of a commercial agreement, particularly where it is shown that the parties negotiated on equal footing. The SCC also addressed the question of whether it is necessary to have a territorial limitation on a non-solicitation covenant and decided that it was not, because the limitation can be determined by analyzing the target customers.

This case concerned non-competition and non-solicitation covenants found in an agreement of purchase and sale pursuant to which Mr. Payette and his business partner sold the assets of several Quebec companies in the crane rental business to Guay Inc. for C$26-million. The covenants applicable to the selling companies ran for a period of five years from the closing date of the transaction and against Mr. Payette and his business partner for five years from the date on which they ceased employment with Guay. After Mr. Payette's termination without cause, he began a new job with a competitor and several of Guay's most experienced employees left to work with Payette at his new place of employment.

The Quebec Superior Court dismissed Guay's action against Payette and his new employer, applying Quebec law applicable to employment covenants, which provides that an employer cannot rely on post-employment restrictions when it terminates an employee without just cause (referred to in Quebec as "serious reason"). On appeal, the majority of the Quebec Court of Appeal held that the restrictions were binding on Payette because the obligations had been assumed by him in the agreement of purchase and sale and their purpose was to protect Guay's substantial investment.

The SCC agreed with the Quebec Court of Appeal and upheld the enforceability of the covenants against Payette.

In its reasons for decision, the SCC articulates the policy reason for the application of different rules to restrictive covenants in the employment context, which is the presumed imbalance of power between the employee and the employer. No such imbalance is presumed in the vendor-purchaser relationship such that the rules applicable to enforceability are different, at least in cases where the parties negotiated on equal terms and were advised by competent professionals.

Agreeing with the Court of Appeal that the facts supported a finding that the restrictive covenants were made in relation to the sale of assets, the SCC outlined the consequences of applying the commercial law analysis.

First, the burden of proof shifts to the vendor (in this case, Payette) to prove that the restrictive covenants are unreasonable, applying the commercial law rules that favour the application of such restrictive covenants. Commercial restrictive covenants, unlike covenants found in employment agreements which are presumptively void as against public policy, are presumptively enforceable.

Second, although the court must still consider whether the temporal and territorial limitations are limited, it will do so considering whether the covenants are necessary for the protection of the buyer in the circumstances. The factors to be considered include:

  1. The sale price
  2. The nature of the business's activities
  3. The parties' experience and expertise
  4. The fact that the parties had access to the services of legal counsel and other professionals
  5. The circumstances of the parties' negotiations.

In the result, the term (five years from the end of employment) and the territorial reach of the restrictive covenants (the whole province of Quebec although the business was principally carried on in the Montréal area) were found to be reasonable, as was the scope of the covenants, having regard to the fact that the parties were on equal footing throughout the negotiations and the highly specialized nature of the business's activities.

In addition, the SCC's decision contains some useful guidance about the analysis of non-solicitation provisions, addressing the question of whether or not a clause restricting solicitation of customers must contain a territorial limitation. The SCC finds that such a limitation is not necessary because "such a limitation can easily be identified by analyzing the target customers." The SCC goes on to say that in the "modern economy" and in the face of new technologies, "customers are no longer limited geographically, which means that territorial limitations in non-solicitation clauses have generally become obsolete".

It is clear from this decision that the "commercial context" lens for the assessment of the enforceability of restrictive covenants requires that courts give substantial deference to the parties' bargain in cases where the evidence establishes that the parties were truly on equal footing. However, it is equally clear from the SCC's reasoning that, in a transaction where the parties are not so evenly matched, significantly more "rigour and intensity" would be applied to assessing the enforceability of the restrictive covenants. Moreover, this case should not be read to suggest that courts will not look closely at whether the restrictive covenants are necessary for the protection of a buyer, in the circumstances of each transaction.

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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