Non-compete clauses are included in virtually all purchase and sale agreements. They are designed to ensure that purchasers realize the full value of the acquired business by, for example, prohibiting competition from vendors within a defined area for a certain amount of time.1 There is no question that such clauses are valuable to purchasers and essential in the mergers and acquisition context.
The Canadian Competition Bureau (the "Bureau") has long recognized that non-compete clauses "can serve legitimate purposes". However, the Bureau's approach to non-compete clauses has been revised in its updated Competitor Collaboration Guidelines (the "CCGs"), which were issued on May 6, 2021 – see our prior blog post titled " New Competitor Collaboration Guidelines". Significantly, as discussed in more detail below, the Bureau has signalled that it may consider such clauses under the criminal cartel provisions in the Competition Act (the "Act") where they, for example, amount to a market allocation agreement or there is evidence that they are nothing more than a "sham".
Non-Compete Clauses Must Be Unambiguous and Reasonable
It is well-recognized that covenants in restraint of trade are prima facie invalid as being contrary to public policy. That being said, courts have acknowledged the importance of allowing parties the freedom to contract and, as such, will enforce restraints of trade where they are reasonable between the parties and with reference to the public interest. Specifically, restraints of trade – including non-compete clauses – will be enforced where they are unambiguous and reasonable with respect to length, list of prohibited activities and geographic scope having regard to the parties' interests. Canadian courts, unlike courts in other jurisdictions (including the United States), will also refuse to "read-down" an unreasonable restraint, making it all the more important for such restraints not to over-reach,
Competition Bureau Approach to Non-Compete Clauses
As noted above, the Bureau has recognized the importance of non-compete clauses. For example, the CCGs – both the original guidelines and the updated guidelines issued last week – state that "[n]on-compete clauses are common in a number of different types of agreements and can serve legitimate purposes, such as ensuring that a purchaser realizes the full value of a purchased business by not being required to compete against the vendor for customer loyalty".
While the original guidelines noted that "[n]on-compete clauses ... entered into in connection with a merger ... [would be] examined as part of the assessment of the transaction under [the merger provisions] of the Act", the updated guidelines include a few important changes that need to be considered and kept in mind by merging parties and their counsel. In particular, the updated guidelines now include the bolded language set out below:
Non-compete clauses that are entered into in connection with a merger ... are generally examined as part of the assessment of the transaction under [the merger provisions] of the Act. However, in rare instances they may be considered under [the criminal cartel provisions] of the Act, for example where the non-compete may amount to a market allocation agreement, or under [the civil agreements provisions] of the Act, for example where the effect of a non-compete agreement is uncertain at the time when the merger is reviewable under [the merger provisions] of the Act.
Separately, the updated guidelines also include specific language addressing "sham" agreements, which could potentially extend to unreasonable and fraudulent non-compete clauses. Specifically, the updated guidelines provide as follows:
The Bureau is cognizant that parties may attempt to structure or design agreements or collaborations to avoid scrutiny under [the criminal cartel provisions of the Act]. Regardless of formality or enforceability, where the Bureau has evidence that a collaboration or agreement is a sham it will consider the arrangement under the most appropriate section of the Act.
Implications For Merger Parties
It is clear that legitimate non-compete clauses, which include those that are unambiguous and reasonable with respect to length, list of prohibited activities and geographic scope having regard to the parties' interests, will continue to be examined under the merger provisions of the Act. However, concerns could potentially arise under other provisions – including the criminal cartel provisions – if a non-compete clause is ambiguous or goes further than necessary to protect the parties' interests. This may be the case, for example, where a non-compete clause extends to products or geographies outside the scope of the transaction, thereby resulting in a market allocation agreement that is not necessary to ensure that the purchaser realizes the full value of the acquired business.
Given the recent changes to the CCGs, merging parties and their counsel will need to carefully consider the scope of non-compete clauses included in purchase and sale agreements. In particular, they will need to ensure that such clauses are unambiguous, reasonable and justifiable having regard to the transaction in question. Failing to do so could potentially expose the merging parties to significant criminal penalties, which include fines of up to $25 million and/or imprisonment for up to 14 years.
If you have questions about the application of the Competition Act to non-compete clauses, you can reach out to any member of Fasken's Competition, Marketing & Foreign Investment group. Our group has significant experience advising clients on all aspects of Canadian competition law.
The information and guidance provided in this blog post does not constitute legal advice and should not be relied on as such. If legal advice is required, please contact a member Fasken's Competition, Marketing & Foreign Investment group.
1 For greater clarity, this blog post considers non-compete agreements entered into between the purchaser and vendor entities. Often, share purchase agreements will also require that certain key individuals related to the vendor (for example, certain senior officers) enter into individual non-compete agreements with the purchaser. Such agreements raise additional issues, which are outside of the scope of this blog post.
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.