Purchase and sale agreements often contain restrictive covenants that limit a party’s activities following the completion of the transaction. One common restrictive covenant is a non-competition and/or non-solicitation clause.
The purpose of these clauses is to protect a purchaser’s interest in the business being acquired, by restricting the seller’s ability to compete with or solicit employees or customers from that business. Such clauses often address the duration and scope of the restriction.
While a non-competition clause is a valid method of protecting a purchaser’s interests, the restriction must be no more than what is reasonably necessary to protect those interests.[1]
If a non-competition clause is found to be overly broad or unreasonable, a court may refuse to enforce it, or it may “notionally sever” and ‘read down’ the clause.[2] This means the court will interpret the unreasonable clause in a way that limits its intended effect.
A Battle of Interests
Parties to a sale may have competing interests regarding the seller's post-sale activities as they relate to the business sold. Non-competition clauses seek to balance those interests. When courts are asked to interpret these clauses, further interests are engaged; the parties’ rights to freely contract, including agreeing to limitations on business activities, and the competing policy interest of maintaining free and open trade, which favours limiting restrictions on business activities.
Commercial vs. Employment Agreements
Courts approach restrictive covenants in commercial agreements differently than those in employment agreements. Courts are typically deferential to restrictive covenants in commercial agreements between contracting parties, and there is a presumption that a restrictive covenant is enforceable. The rationale is that in commercial agreements the parties are presumed to be on “equal footing”, to have equal bargaining power, and there is a greater flow of consideration. Put another way, “ [c]ompetently advised parties with equal bargaining strength, expertise, experience and access to resources are the best judges of what is reasonable as between them”.[3]
In contrast, with respect to employment agreements there is a power imbalance that characterizes the relationship between an employee and employer. In fact, Ontario recently introduced a statutory prohibition on the inclusion of non-competition language in employment agreements unless the employee sold or leased a business to the employer and immediately following such sale or lease enters into an employment agreement to become an employee of the business, or the employee is the president of, or holds an executive position with, the employer’s business. [4]
The Construction of Restrictive Covenants
As noted above, courts generally do not interfere with reasonable restrictive clauses in commercial agreements. In assessing whether a restrictive clause is reasonable, the court will first ask whether the clause is clear enough to be enforceable. Beyond the question of clarity, the following factors will generally guide the court’s assessment of the reasonableness of a restrictive clause in a commercial agreement; (i) geographic scope, (ii) temporal scope, and (iii) scope of activity.[5] The focus of the courts’ analysis is generally on the first two factors, which are addressed below, but it is worth noting that courts have “consistently” upheld restrictive covenants that limit the seller from carrying on business “similar to” the business being sold.[6]
(i) Geographical scope of restriction
Reasonable clauses that restrict the area or region in which the seller can compete have included restrictions based on where the buyer conducts business, or to where it will expand.[7] Courts have allowed broad geographic restrictions, however the region must be identified with precision. For example, in one case, a restraint on competing within the entire Province of Ontario was deemed valid. However, the additional restriction of “a surrounding 10 km ring” beyond the Province of Ontario was held to be arbitrary and was therefore severed from the contract.[8] In another case, the court found that the geographic area defined in the clause as “Metropolitan City of Vancouver” was ambiguous and thereby unenforceable because there is no such defined area.[9]
In a scenario where a company’s business primarily occurs at sites other than at the company’s place of business/office, such as a crane rental business where cranes are used at various construction sites, the courts have accepted an expanded geographic scope.[10]
While the territory to which the restrictive covenant applies must be identified, a determination that a non‑solicitation clause is reasonable and lawful does not generally require a territorial limitation.[11]
(ii) Time limit of restriction
Temporal restrictions must have a fixed, outside limit to be enforceable.[12] There is however no bright line rule about what constitutes a reasonable period and courts have permitted restraints on competing for periods as long as ten years.[13]
Summary
Restrictive covenants – in the form of non-competition or non-solicitation clauses – are legitimate tools to protect a party’s economic interests. While courts typically do not disturb these clauses where they appear in M&A contexts, they must still be carefully drafted to minimize the risk that they become invalidated. While a purchaser, understandably, wants to draw the limits as broadly as possible, it should tailor a clause to what is reasonably necessary to safeguard its interest.
[1] Guay Inc. v. Payette, 2013 SCC 45 [Guay] at para 61.
[2] Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6 [Shafron] at paras 29-30.
[3] Human Logistics v. PAL Airlines, 2018 ONSC 7433 [Human Logistics] at paras 70-72.
[4] Employment Standards Act, 2000, SO 2000, c 41, ss 67.1, 67.2(1)–(5).
[5] Ted Thomson Management Inc. v. 1331503 Ontario Limited et. al., 2013 ONSC 26 at para 30; Martin v. ConCreate USL Limited Partnership, 2013 ONCA 72 at paras 49-54.
[6] GDL Solutions Inc. v. Walker et al., 2012 ONSC 4378 [GDL Solutions] at para 63.
[7] Human Logistics at paras 110-111.
[8] GDL Solutions.
[9] Shafron.
[10] Guay at para 67.
[11] Ibid at para 69.
[12] Martin at para 59.
[13] Rogers Communications Inc. v. Shaw Communications Inc., 2009 CanLII 48839 (ONSC).
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