Canada: Supreme Court Of Canada Affirms LawFulness Of Restrictive Covenants In Commercial Context

In Payette v. Guay inc. the Supreme Court of Canada unanimously upheld non-compete and non-solicit provisions in a contract arising from the sale of a business. The decision distinguishes between a restrictive covenant negotiated in the commercial context with one contained in the employment context where there is often unequal negotiating power. This case is welcome news for businesses across the country which seek to enforce such covenants to protect their interests.

Major points emerging from the case include:

  • the courts are cognizant of the need to protect the goodwill and loyalty that attach to the sale of a business;
  • the appropriate length, nature of activities and geographic scope of restrictive covenants can vary considerably in light of the nature of a business; and
  • in Québec, the vendor seeking to avoid being bound by a restrictive covenant in the commercial context has the burden of proving it is unenforceable.

While the case was decided under the Civil Code of Québec, the Court also applies principles from the common law in its analysis, rendering the case of interest nationally.

The Facts

Guay inc. (Guay) is a crane rental company. In 2004, it purchased assets belonging to Group Fortier, also in the crane rental business. Group Fortier was owned and operated by Yannick Payette (Payette) and his business partner. To ensure a smooth transition, the two business partners agreed to work for Guay inc. for six months after the sale. The contract of sale also contemplated the possibility of further future employment beyond that period. It stated that Payette would be bound by a non-solicitation and non-competition agreements for five years from the date that employment with Guay ceased.

Payette continued to work for Guay for more than four years after the six-month transitional period, initially on a first-term contract and then on a contract of indefinite duration, before he was dismissed without cause. Seven months later, he began employment with a competitor of Guay. A few days after that, Guay lost seven of its most experienced employees to that competitor. Shortly thereafter, the Québec Superior Court granted Guay's motion for an interlocutory injunction. The terms of this order were subsequently renewed until the hearing on the merits.

On the merits, the Québec Superior Court refused to issue a permanent injunction ordering Payette to comply with the restrictive covenants. On appeal, the Québec Court of Appeal overturned that decision and issued a permanent injunction ordering Payette to comply with the covenants for a period of five years upon termination of his employment with Guay.

The Supreme Court of Canada's Decision

The Court recognized that the enforceability of a restrictive covenant will vary depending on whether the covenant was entered into in the context of a sale of a business or a contract of employment. In the former situation, a purchaser is also buying the goodwill of the business – goodwill that the employees/vendors could take with them if they enter into competition.  While similar concerns often arise in the employment context, the legal principles applied in the context of a sale of a business are different, in part because power imbalances are less likely in the business sale context.

The Civil Code of Québec

With the 1994 reform to the Civil Code of Québec, the Québec legislature introduced provisions in order to redress the imbalance of economic powers existing between an employer and employee. In particular, non-competition covenants in the context of employment contracts were subject to restrictions in order to ensure that employees would not be unfairly prohibited from making a living. This protection is only afforded to employment contracts.

The Supreme Court first had to determine whether the restrictive covenants were made in the context of a contract for the sale of assets or that of a contract of employment. The Court adopted a contextual approach in order to make this determination, examining both the intention of the parties and the wording of the disputed provisions.

The Court held that, on the facts of this case, both the wording and the factual context behind the acceptance of such obligations supported the conclusion that the non-competition and non-solicitation covenants could not be dissociated from the contract for the sale of assets. In reaching this conclusion, the Court held that entering into a separate contract of employment did not mean that the restrictive covenants had to be interpreted on the basis of the rules governing employment contracts. Moreover, the Court also held that the reference to termination of employment, as the starting point of the non-compete period, did not have the effect of associating the restrictive covenant to a contract of employment.

The Reasonableness of the Covenants

The Supreme Court then analyzed whether the non-competition and non-stipulation covenants were reasonable. The Court held that, in the commercial context, the burden lies on the vendor to establish that the covenants were not reasonable. The following factors were considered in assessing the reasonableness of the covenants: the sale price; the nature of the business's activities; the parties' experience and expertise; access to the services of legal counsel and other professionals; as well as the circumstances of the negotiations.

Payette failed to discharge his burden in this case. The fact that he acknowledged in the agreement at issue that the covenants were reasonable was not determinative. It was, nonetheless, a factor to be considered in assessing the covenants' validity. Although Group Fortier had carried on the "vast majority" of its business in the Montréal area, the fact that the covenant applied to all of Québec did not render it unreasonable in light of the unique nature of the crane industry, notably, the fact that cranes are mobile.

Turning to the non-solicitation covenant, the Court held that it was enforceable notwithstanding the lack of a territorial limitation. While such a limitation is necessary for a non-competition clause, it is not so for a non-solicitation clause. Reasons for this include: the non-solicitation clause's application to a narrower scope of activities; the fact that limitations on it can easily be identified by analyzing the target employees and customers; and the realization that, in a modern economy, customers are no longer limited geographically.

Conclusion

This decision recognizes the importance of protecting the legitimate interests of the purchaser in the context of a sale of a business through the enforceability of the restrictive covenants. Of course, this does not immunize such covenants from judicial scrutiny. The case also provides an interesting complement to the Ontario Court of Appeal decision of Martin v. ConCreate USL Limited Partnership, released earlier this year (and analyzed in our Osler Update of February 7, 2013). There, the Court held that restrictive covenants entered into in the sale of a business were unenforceable despite possibly being of shorter duration. However, this was due to unusual terms in those covenants that made it impossible to establish a clear outside duration – a problem that did not exist based on the facts of Payette v. Guay.

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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