Are Restrictive Covenants Enforceable in Business and Employment Contracts?

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restrictive covenants

Restrictive covenants, or provisions in a contract that restrict the seller or employee from setting up a new shop or working for a competitor for a period of time, and within a particular geographical area, are fairly common in contracts for the purchase of a business and employment contracts.

The Supreme Court of Canada has recently clarified some of the factors and considerations necessary in order to enforce these covenants. Buyers and sellers and employers and employees reviewing these provisions before signing a contract should be aware of the Court’s key points.

An article from Denton’s summarizes the key points from a recent Supreme Court of Canada decision in Payette v. Guay Inc

  • The rules applicable to restrictive covenants relating to employment will differ depending on whether those covenants are linked to a contract for the sale of a business or to a contract of employment. This reflects the imbalance of power that generally characterizes the employer-employee relationship. No imbalance of power is presumed to exist in the vendor-purchaser relationship and so these rules will not have an equivalent in the commercial context.

  • The common law rules for restrictive covenants relating to employment do not apply with the same rigour or intensity where those obligations are assumed in the context of a commercial contract, particularly where the parties negotiated on equal terms, were advised by competent professionals and the contract did not create an imbalance between them.

  • In order to determine whether a restrictive covenant is linked to a contract for the sale of assets or to a contract of employment, it is important to clearly identify the reason why the covenant was entered into. The goal of the analysis is to identify the nature of the principal obligations under the master agreement and determine why and for what purpose the accessory obligations of non-competition and non-solicitation were assumed.

  • A restrictive covenant in the commercial context is lawful unless it can be established on a balance of probabilities that its scope is unreasonable. Thus the burden of proof will be on the vendor to prove that the restrictive covenant is unreasonable.

  • An acknowledgement by the parties subject to the restrictive covenant that the covenant is reasonable is not determinative, but it is a relevant factor and indicator that the Court will consider when determining whether the covenant is reasonable.

  • In the commercial context, a non-competition covenant will be found to be reasonable and lawful provided that it is limited, as to its term, territory and applicable activities, to whatever is necessary for the protection of the legitimate interests of the party in whose favour it was granted. The factors that may be considered include the sale price, the nature of the business’ activities, the parties’ experience and expertise, and the fact that the parties had access to the services of legal counsel and other professionals.

  • While in the case of a non-competition covenant, the applicable territory must be identified, a non-solicitation covenant may be considered reasonable and lawful absent a territorial limitation. In the modern economy, with new technologies and customers who are no longer geographically limited, territorial limitations in non-solicitation clauses have generally become obsolete. 

If you would like to be sure about what a particular restrictive covenant covers and whether it needs to be modified in order to be enforceable, please contact us.

 

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