Restrictive covenants in employment contracts
Background
Employers often attempt to protect themselves from competition from former employees by including non-competition and non-solicitation clauses, known as restrictive covenants, in employment contracts. Non-competition clauses prohibit competition from former employees for a prescribed period of time and within a defined geographic area. Non-solicitation clauses prohibit solicitation of company clients or other employees by former employees.
Courts generally treat restrictive covenants as unenforceable because they limit a former employee's ability to earn a living. Such covenants will only be found enforceable if they are reasonable between the parties and with reference to the public interest. When determining whether a restrictive covenant is reasonable, the courts are required to balance the competing interests of free and open competition against the right of parties to enter into contracts.
There are circumstances in which restrictive covenants are necessary to protect the employer's interests. Courts have held that if a non-solicitation clause will adequately protect an employer's interests, then only in exceptional circumstances will the nature of the employment justify a non-competition clause. In the case examined below the Manitoba Queen’s Bench ruled the nature of the employment relationship was such that the non-competition and non-solicitation clauses should be upheld.
The case: Farm Business Consultants Inc. v. Kindret (2002), 17 C.C.E.L. (3d) 54
Farm Business Consultants Inc. (FBC) was in the business of providing tax advice, preparation of tax returns, consulting and bookkeeping services. Wayne Kindret was an employee who worked for FBC from 1987 until he resigned in January 1999. At the time of his resignation, he was a senior service representative for FBC’s clients in southeastern Manitoba and northwestern Ontario.
In December 1997 FBC and Kindret entered into a written employment agreement which set out the terms and conditions of employment. Additionally, in October 1998 Kindret signed an acknowledgement form with respect to FBC's employee handbook indicating he understood the contents of the handbook and would abide by its terms.
The employment agreement and handbook contained non-competition and non-solicitation clauses which set out his obligations to FBC following the termination of his employment. The covenants provided that for a one-year period the employee would not:
•intentionally act in any manner detrimental to the relations between FBC and its clients.
•solicit or service any of FBC's clients with whom the employee dealt with during his employment with FBC.
•enter into contractual relations with FBC's clients, with whom the employee dealt with or gained knowledge of during his employment with FBC, for the purpose of providing services similar to those provided by FBC.
Following Kindret's resignation, 26 clients left FBC to continue with Kindret as their representative. Kindret admitted to providing services to these clients in the years 1999 and 2000, and it was not disputed that the services he provided were similar to those provided by FBC. There was no evidence that Kindret solicited these clients.
The court considered whether the non-competition and non-solicitation clauses were reasonable. The reasonableness of such clauses was determined by answering the following questions: does the employer have a proprietary interest worthy of protection?; are the time and geographical limits too broad?; and are the covenants enforceable against competition generally?
The court found FBC had a proprietary interest in retaining its clients. The restrictive covenants were an effective tool in preventing former employees from taking clients from FBC, particularly where these former employees would have a competitive advantage over FBC by using knowledge of both the business and affairs of clients as well as knowledge of FBC obtained during the course of employment. In addition the court found the time and geographical limits were not too broad.
Finally the court found the covenants did not restrict competition because FBC's clients would not suffer adverse consequences through the loss of Kindret for a limited period of time. As a result, the court found the covenants were enforceable and that Kindret breached them and ordered him to pay FBC damages for loss of profits.
Tips for employers
It is up to the employer to show non-competition and non-solicitation clauses are reasonable. To ensure clauses are enforceable, consider the following points:
•Do not overreach. The clauses must be reasonable as they relate to both the length of time restricting an employee from competing or soliciting, and the geographic scope. The reasonableness of such clauses will vary according to a variety of factors, including the terms contained in the employment contract, the nature of the work, the nature of the employer’s business, the extent of competition, whether clients are exclusive to the employer, and whether the employee possesses confidential information about the employer's business.
•Non-competition clauses should be limited to employees in key positions, employees who regularly come into contact with the employer's clients, and employees who possess confidential information about the employer's business.
•Courts have found that an employer is entitled to protect its trade secrets, confidential business information, data about its customers, clients and suppliers and goodwill from being exploited by a former employee. However, an employer cannot restrict a former employee from using his or her skills, knowledge and expertise, even if gained in the course of employment.
•When an employer's legitimate business interests can be adequately protected by a non-solicitation clause, courts will not uphold a non-competition clause.
•When entering into an employment contract which contains a non-competition or a non-solicitation clause, an employer should bring the clauses to the attention of the employee before she signs the contract in order to ensure she knows the extent of her obligations. The safest approach is to encourage the employee to seek independent legal advice before signing the employment contract.
•Courts are not likely to uphold a non-competition or non-solicitation clause where an employee has been wrongfully or constructively dismissed.
•Be sure the language used in non-competition and non-solicitation clauses is precise. Courts will not uphold ambiguous or vague clauses.
This in-depth look at restrictive covenants was provided by Mark Mason, a litigation and employment law lawyer with Goodman and Carr LLP in Toronto. He can be reached at [email protected].
Employers often attempt to protect themselves from competition from former employees by including non-competition and non-solicitation clauses, known as restrictive covenants, in employment contracts. Non-competition clauses prohibit competition from former employees for a prescribed period of time and within a defined geographic area. Non-solicitation clauses prohibit solicitation of company clients or other employees by former employees.
Courts generally treat restrictive covenants as unenforceable because they limit a former employee's ability to earn a living. Such covenants will only be found enforceable if they are reasonable between the parties and with reference to the public interest. When determining whether a restrictive covenant is reasonable, the courts are required to balance the competing interests of free and open competition against the right of parties to enter into contracts.
There are circumstances in which restrictive covenants are necessary to protect the employer's interests. Courts have held that if a non-solicitation clause will adequately protect an employer's interests, then only in exceptional circumstances will the nature of the employment justify a non-competition clause. In the case examined below the Manitoba Queen’s Bench ruled the nature of the employment relationship was such that the non-competition and non-solicitation clauses should be upheld.
The case: Farm Business Consultants Inc. v. Kindret (2002), 17 C.C.E.L. (3d) 54
Farm Business Consultants Inc. (FBC) was in the business of providing tax advice, preparation of tax returns, consulting and bookkeeping services. Wayne Kindret was an employee who worked for FBC from 1987 until he resigned in January 1999. At the time of his resignation, he was a senior service representative for FBC’s clients in southeastern Manitoba and northwestern Ontario.
In December 1997 FBC and Kindret entered into a written employment agreement which set out the terms and conditions of employment. Additionally, in October 1998 Kindret signed an acknowledgement form with respect to FBC's employee handbook indicating he understood the contents of the handbook and would abide by its terms.
The employment agreement and handbook contained non-competition and non-solicitation clauses which set out his obligations to FBC following the termination of his employment. The covenants provided that for a one-year period the employee would not:
•intentionally act in any manner detrimental to the relations between FBC and its clients.
•solicit or service any of FBC's clients with whom the employee dealt with during his employment with FBC.
•enter into contractual relations with FBC's clients, with whom the employee dealt with or gained knowledge of during his employment with FBC, for the purpose of providing services similar to those provided by FBC.
Following Kindret's resignation, 26 clients left FBC to continue with Kindret as their representative. Kindret admitted to providing services to these clients in the years 1999 and 2000, and it was not disputed that the services he provided were similar to those provided by FBC. There was no evidence that Kindret solicited these clients.
The court considered whether the non-competition and non-solicitation clauses were reasonable. The reasonableness of such clauses was determined by answering the following questions: does the employer have a proprietary interest worthy of protection?; are the time and geographical limits too broad?; and are the covenants enforceable against competition generally?
The court found FBC had a proprietary interest in retaining its clients. The restrictive covenants were an effective tool in preventing former employees from taking clients from FBC, particularly where these former employees would have a competitive advantage over FBC by using knowledge of both the business and affairs of clients as well as knowledge of FBC obtained during the course of employment. In addition the court found the time and geographical limits were not too broad.
Finally the court found the covenants did not restrict competition because FBC's clients would not suffer adverse consequences through the loss of Kindret for a limited period of time. As a result, the court found the covenants were enforceable and that Kindret breached them and ordered him to pay FBC damages for loss of profits.
Tips for employers
It is up to the employer to show non-competition and non-solicitation clauses are reasonable. To ensure clauses are enforceable, consider the following points:
•Do not overreach. The clauses must be reasonable as they relate to both the length of time restricting an employee from competing or soliciting, and the geographic scope. The reasonableness of such clauses will vary according to a variety of factors, including the terms contained in the employment contract, the nature of the work, the nature of the employer’s business, the extent of competition, whether clients are exclusive to the employer, and whether the employee possesses confidential information about the employer's business.
•Non-competition clauses should be limited to employees in key positions, employees who regularly come into contact with the employer's clients, and employees who possess confidential information about the employer's business.
•Courts have found that an employer is entitled to protect its trade secrets, confidential business information, data about its customers, clients and suppliers and goodwill from being exploited by a former employee. However, an employer cannot restrict a former employee from using his or her skills, knowledge and expertise, even if gained in the course of employment.
•When an employer's legitimate business interests can be adequately protected by a non-solicitation clause, courts will not uphold a non-competition clause.
•When entering into an employment contract which contains a non-competition or a non-solicitation clause, an employer should bring the clauses to the attention of the employee before she signs the contract in order to ensure she knows the extent of her obligations. The safest approach is to encourage the employee to seek independent legal advice before signing the employment contract.
•Courts are not likely to uphold a non-competition or non-solicitation clause where an employee has been wrongfully or constructively dismissed.
•Be sure the language used in non-competition and non-solicitation clauses is precise. Courts will not uphold ambiguous or vague clauses.
| Cases of note J.G. Collins Insurance Agencies Ltd. v. Elsley Estate [1978] 2 S.C.R. 916 (S.C.C.) After 17 years, the employee resigned and recommenced his own business, taking 200 unsolicited customers with him. The employee had entered into a specific non-competition covenant with a period of five years and the area confined to the county in which he had previously worked. The court found the employee had acquired a special and intimate knowledge of the employer's customers and means of influence over them. The court held the non-competition covenant was reasonable since a non-solicitation covenant would not have been adequate to protect the employer's proprietary interest. Winnipeg Livestock Sales Ltd. v. Plewman (2000), Carswell Man 474 (Man C.A.) Plewman worked as an auctioneer for Winnipeg. He entered into an agreement which provided that, for a period of 18 months following his termination, he would not solicit business from or provide livestock auctioneering services to anyone in Manitoba who was in competition with Winnipeg. Four years later, Plewman terminated his employment to provide similar services to a competitor. Winnipeg obtained an interim injunction preventing him from working as an auctioneer with the competitor. On appeal, the court held the non-solicitation covenant was unreasonable because the sole purpose of the covenant was to prevent Plewman from acting as an auctioneer for a competitor of Winnipeg. |
This in-depth look at restrictive covenants was provided by Mark Mason, a litigation and employment law lawyer with Goodman and Carr LLP in Toronto. He can be reached at [email protected].
