The Test of Enforcement
It is a legal presumption that all restrictive covenants are contrary to public policy and void prima facie unless they may be shown to be justified as reasonable with respect to the interests of the immediate parties and also in the public interest. The holder of the covenant must prove the former and the offending party the latter, once the former is established.
There is a different test applied in circumstances where the covenant arises out of the sale of a business, in which case the covenant is much more likely to be enforced, as a consequence of it being a term negotiated between two equals in the bargaining process, where the buyer is acquiring the goodwill of the vendor's business.
An employment agreement will be examined to determine its context, i.e., did it arise due to the sale of a business or an equity participation akin to a capital interest.
To examine the enforceability of a restrictive covenant, the court will apply the following tests:
- Does the employer have a legitimate business interest worthy of protection ?
- Does the covenant restrain trade ?
- Is the restraint imposed fall into the class of an exceptional case – such as a commercial lease which limits the business to a certain class of trade and prohibits others ?
- Is the proposed restraint reasonable between the parties ?
- Is the restraint reasonable with respect to the public interest ?
The latter two factors require a contextual review of the relevant facts of the case. This will include facts such as the essence of the business, the existence of any trade secrets, confidential information and the position of the affected person in the organization – was he a floor sweeper or an influential decision maker.
The covenant must be clear and precise. Any inherent ambiguity will lead to its demise. A vivid example of this principle is found in the Supreme Court of Canada decision in Safron v KRG Insurance Brokers in which the proposed covenant defined the protected geographic area as the “Metropolitan City of Vancouver”, which regrettably for the employer was not a distinct legal entity. The covenant was found to be ambiguous and unenforceable.
Generally the RC in an employment context will be examined to determine its reasonableness by reviewing:
- its extent – what activities are prohibited, and
- its geographical restriction and
- the time of its applicability.
For an excellent modern review of these issues, see the decision of Mr. Justice Perell of the Ontario Superior Court in Martin v. ConCrete USL LP et al, February 28, 2012. It is to be noted that this case arose from the sale of a business. The Court of Appeal reversed, finding that the time period of the non-compete and non-solicit was open ended and hence unenforceable.
The test for the draftsman is to develop a covenant which sets out rational restrictions on the ability of the subject to compete against his prior employer. A blanket non-compete will be difficult to enforce. A non-solicit covenant which contains reasonable protective limits, rationalized by the nature of the employee’s day to day central business activities will likely be enforceable. As noted below, a non-solicit clause which adds a provision that the employee cannot accept incoming offers of business from past clients, even when not solicited to do so, will be viewed as a restrictive covenant and subject to its stringent test.
Severance – Notional or Blue Pencil
The Supreme Court considered the concept of the severance of a restrictive covenant in the 2009 decision of Shafron v KRG Insurance Brokers.
Severance, when permitted, may take two forms. “Notional” severance means reading down a contractual provision so as to make it legal. “Blue-pencil” severance consists of removing part of a contractual provision. This latter remedy is resorted to only rare occasions where the part being removed is trivial and not part of the main thrust of the covenant. Neither form of severance was allowed in this case.
Shafron entered into an agreement that was found to be strictly an employment contract, which was an important finding as employment contracts are place under a higher degree of judicial scrutiny than a covenant coming from the sale of a commercial business. The agreement was repeated frequently. On each occasion the covenant prevented Shafron from competing within three year period within the “Metropolitan City of Vancouver”, a legal entity which did not exist.
Apart from the above issue, the Court also stated that when analyzing the test as to whether the covenant is reasonable, the clause in question must be clear and precise:
[27] However, for a determination of reasonableness to be made, the terms of the restrictive covenant must be unambiguous. The reasonableness of a covenant cannot be determined without first establishing the meaning of the covenant. The onus is on the party seeking to enforce the restrictive covenant to show the reasonableness of its terms. An ambiguous restrictive covenant will be prima facie unenforceable because the party seeking enforcement will be unable to demonstrate reasonableness in the face of an ambiguity. As stated at the outset, the main difficulty that arises in this case is the ambiguity of the geographical restriction contained in the covenant. However, before turning to the case at hand, I will discuss the doctrine of severance as it applies to restrictive covenants in employment contracts.
As to the issue of severance, the Court stated that to use notional severance, there should be an obvious or “bright-line” test as to what is illegal. The precedent case referred to involved an illegal rate of interest which was in excess of the criminal rate of 60%. The agreement was read down to the 60% mark.
A blue-pencil severance is effected to apply a blue pencil erasure to the offending words, with affecting the remaining words.
Where severance is applied, in either fashion, the purpose is to give effect to the intentions of the parties when they formed the contract.
With respect to restrictive covenants in particular, allowing severance, the Court concluded, would only encourage the drafter to create overly broad covenants. The decision was that notional severance should not be permitted at all with respect to restrictive covenants and blue-pencil must be used sparingly and “only in cases where the part being removed is clearly severable, trivial and not part of the main purport of the restrictive covenant”.
This view was repeated by the Ontario Court of Appeal in the 2012 decision in Veoila v ES Industrial, which considered and refused to apply the blue-pencil severance.
The Ontario Court of Appeal considered in 2011 the rules of enforceability of such a negative covenant in an employment context in Mason v Chem-Trend. (leave to appeal refused) The Court of Appeal allowed the appeal and set aside the covenant as being unenforceable. The words of the covenant were as follows:
I agree that if my employment is terminated for any reason by me or by the Company, I will not, for a period of one year following the termination, directly or indirectly, for my own account or as an employee or agent of any business entity, engage in any business or activity in competition with the Company by providing services or products to, or soliciting business from, any business entity which was a customer of the company during the period in which I was an employee of the Company, or take any action that will cause the termination of the business relationship between the Company and any customer, or solicit for employment any person employed by the Company. [Emphasis added.]
The Court stated the law as follows:
This court also recently discussed the governing principles that are applicable when considering whether a restrictive covenant in a contract of employment is unreasonable and therefore unenforceable in H. L. Staebler Company Ltd. v. Allan 2008 ONCA 576 (CanLII), (2008), 92 O.R. (3d) 107 (C.A.). They can be summarized as follows:
To be enforceable, the covenant must be “reasonable between the parties and with reference to the public interest.” (Elsley at p. 923)
The balance is between the public interest in maintaining open competition and discouraging restraints on trade on the one hand, and on the other hand, the right of an employer to the protection of its trade secrets, confidential information and trade connections.
“The validity, or otherwise, of a restrictive covenant can be determined only upon an overall assessment of the clause, the agreement within which it is found and all of the surrounding circumstances.” (Elsley at p. 924)
In that context, the three factors to be considered are, 1) did the employer have a proprietary interest entitled to protection? 2) are the temporal or spatial limits too broad? and 3) is the covenant overly broad in the activity it proscribes because it prohibits competition generally and not just solicitation of the employer’s customers?
The plaintiff was employed with the defendant, a Michigan based company in the business of the formulation and manufacture and sale of agents and chemicals for use in the general rubber and tire and related uses around the world.
Mr. Mason was a technical salesperson for 17 years prior to his termination in mid 2009. At the time of termination he was responsible for Canada and certain mid-Atlantic states. The plaintiff had knowledge of the company, its products, its customers and the products such customers purchased and the prices they paid. He had little knowledge of the technical compound lists and formulations. He had no access to the company’s large current or older customer list.
The Court of Appeal noted the presence of other terms of the agreement which protected trade secrets and confidential information. It also stated that the prohibition against dealing with any customers with whom he dealt or the company dealt with in a 17 year period was unreasonable. Such restriction was ambiguous and effectively prohibited the plaintiff from competing for a one year period. The covenant was seen as unreasonable and unworkable and set aside.