Canada: Supreme Court Of Canada Addresses Enforceability Of Restrictive Covenants In Employment Agreements

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Labour & Employment, February 2009

On January 23, 2009, the Supreme Court of Canada released its reasons in Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6, providing additional guidance on how courts will interpret non-competition provisions in employment agreements. In particular, the Supreme Court in Shafron resolved an ongoing issue between the courts in British Columbia and other jurisdictions with respect to when it would be appropriate for a court to rewrite a restrictive covenant limiting an employee's ability to compete with a former employer when the contract, as drafted, is determined to be either too vague or too broad to be enforceable.

The employee in question was the former owner of an insurance business, who had sold the business to a predecessor of his current employer. Since selling the business, the employee had signed a number of employment agreements with both the original purchaser of the business and the current employer after it subsequently bought the business. The more recent agreements contained a restrictive covenant prohibiting post-employment competition with his employer in the "Metropolitan City of Vancouver". KRG Insurance Brokers commenced an action against the employee when he quit his position and started working for a competing insurance brokerage.

At trial, the court refused to enforce the agreement, as it found the term "Metropolitan City of Vancouver" too vague to effectively enforce and as a result struck down the non-competition provision of the employment agreement. The British Columbia Court of Appeal took a different approach and found that it could notionally "sever" or rewrite the agreement by clarifying the geographic scope of the non-competition clause to specific parts of the Greater Vancouver region. If the Court of Appeal's reasons were a significant expansion of when a court will intervene to rework an otherwise unreasonable covenant to make it enforceable, the Supreme Court of Canada, in overturning that decision, has set very strict limitations on a court's ability to sever such covenants.

The Supreme Court considered two different ways to sever a restrictive covenant. First, there is "notional" severance, where a court will, in effect, read down an unenforceable term in order to make it legal and enforceable. The second way to sever a covenant is to apply the "blue pencil" rule and simply delete offending words from the contractual term in order to make it enforceable.

Unlike the B.C. Court of Appeal, the Supreme Court completely rejects the concept of notional severance for restrictive covenants in employment agreements. In other contexts, where notional severance has been applied, courts have been able to apply a bright-line to make an illegal term compliant with the law in order to give effect to the parties' intent (e.g., reducing a contractual interest rate to the maximum permitted by the Criminal Code). In Shafron, the Supreme Court finds that, as it is not possible to draw a bright-line determining the parties' mutual intent, notional severance is inappropriate for non-competition clauses.

The court also rejects the use of notional severance in employment agreements due to the potential power imbalance between employees and employers. While courts have taken a more permissive attitude toward non-compete agreements on the sale of a business, employees do not receive payment for goodwill like the vendor of a business. Given this power imbalance, the Supreme Court finds that employers should not be permitted to negotiate overly broad non-competition provisions, and then rely on the courts to read them down to make them enforceable.

After rejecting the use of notional severance, the Supreme Court went on to also find that courts should be hesitant to apply the blue pencil rule to sever unreasonable non-competition provisions. The court warns that the blue pencil rule should only be used sparingly and only when the section being deleted is "clearly severable, trivial and not part of the main purport of the restrictive covenant". In that regard, it appears clear that cascading restrictions of increasingly smaller scope will not be blue-pencilled to the degree necessary to make the covenant enforceable.

The Shafron decision makes it clear that careful thought and attention need to go into considering the enforceability of a restrictive covenant at the time of drafting. If such covenants are not clear and reasonable at the time, the parties should not expect the courts to amend them in order to ensure their enforceability. Further, while the Shafron decision is an employment case, and the Supreme Court makes it clear that courts permitted broader restrictive covenants on the sale of a business, the principles regarding severing non-competition covenants would largely be applicable in both contexts.

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