Canadian Law Blawg

Is your employment contract valid?

Salespersons’ employment contracts containing non-competition clauses after an employment relationship is terminated along with terms prohibiting the solicitation of former clients may not be enforceable, as a result of the Ontario Court of Appeal’s decision in H.L. Staebler Company Limited v. Allan, et al. 2008 ONCA 576 . Prudent businesspersons will want to review their employees’ employment contracts with their lawyers, in order to determine if their contracts are enforceable.

One method that companies use to guard against the loss of their proprietary information is by inserting non-solicitation clauses in their employees’ employment contracts. This type of provision prohibits a departing employee from soliciting customers of his, or her, former employer. It is quite common for employers to insist that their employees sign an employment contract containing a non-solicitation clause.

A non-competition clause in an employment contract prohibits a departing employee from taking a new position in the same industry. Such clauses usually contain geographic boundaries and time limits. Despite their prevalence in employment contracts, the general rule in most common law jurisdictions is that non-competition clauses in employment contracts are not enforceable.

The public policy reasons in favour of open competition trumping freedom of contract were established in cases like Nordenfelt v. Maxim Nordenfelt Guns & Ammunition Company Limited, [1894] A.C.535 at 565 [H.L.]:

The public have an interest in every person carrying on his trade freely: so has the individual. All interference with individual liberty of action in trading, and all restraints of trades themselves, if there is nothing more, are contrary to public policy, and are therefore void. That is the general rule.

Court cases interpreting the enforceability of non-competition clauses turn on balancing the competing interests between restricting restraints of trade and upholding the right to contract. Ordinarily, courts are disinclined to restrict parties’ freedom to contract unless a more compelling societal value needs to be paramount. Nordenfelt was cited with approval by the Supreme Court of Canada in Elsley v. JPG Collins Insurance Agencies Limited, [1978] 2 S.C.R. 916, the leading Canadian case dealing with non-competition clauses. In Elsley, a vendor of a business had a 10-year non-competition clause as part of the sale of his business along with a non-competition clause contained in his corresponding employment contract for 5-years following his employment’s termination. In light of the court’s perception of Elsley as a knowledgeable person of equal bargaining power in his negotiations with the business’ purchaser, the non-competition clauses were enforced.

Dickson J. observed that “it is difficult to envision a factual situation in which an employee would be in a better position than that of Elsley in the present case, to obtain personal knowledge of and influence over the customers of his employers”. Dickson J. concluded that in his view a covenant against solicitation would not have been adequate protection for the purchaser’s protection of its proprietary interest. Dickson J. also noted that when the employment agreement was drafted, it was known that Elsley had or would acquire a “special and intimate knowledge of the customers of his prospective employer and the means of influence over them.” Similarly, in Friesen v. McKague [1992], 96 D.L.R. [4th] 341, Scott C.J. stated that a non-competition clause should be enforced “where the nature of the employment will likely cause customers to perceive an individual employee as the personification of the company or employer.”

In Elsley, Dickson J. discussed the distinction made by courts between restrictive covenants contained in an agreement for the sale of a business and one contained in an employment contract at p.924:

A person seeking to sell his business might find himself with an unsaleable commodity if denied the right to assure the purchaser that he, the vendor, would not later enter into competition. Difficulty lies in definition of the time during which, and the area within which, the non-competitive covenant is to operate, but if these are reasonable, the courts will normally give effect to the covenant.

A different situation, at least in theory, obtains in the negotiation of a contract of employment wherein an imbalance of bargaining power may lead to oppression and a denial of the right of the employee to exploit, following termination of employment, and the public interest and in his own interest, knowledge and skills obtained during employment. Again, a distinction is made. Although blanket restrictions on freedom to compete are generally held unenforceable, the courts have recognized and afforded reasonable protection to trade secrets, confidential information and trade connections of the employer.

However, determining reasonableness is an amorphous, subjective test as noted earlier by Dickson J. at page 923 in Elsley:

The test of reasonableness can be applied, however, only in the peculiar circumstances of the particular case. Circumstances are of infinite variety.

In determining reasonableness, a court may examine industry practices; however, evidence of industry standards (i.e. competitors using similar employment contracts) does not necessarily justify a restrictive covenant period.

Even in Nordenfelt, Lord MacNaghten noted that a restraint on trade could be valid if it was reasonable in the interests of the contracting parties and also reasonable in the public interest. Therefore, some employment agreements can contain clauses that contain reasonable restrictive covenants restricting competition. Exceptional circumstances could extend to a key employee in senior management; or, an owner-operator selling an interest in the business. Otherwise, in all likelihood, a non-competition clause will not be enforced. Although corporate-commercial solicitors often insert such terms as a psychological deterrent for departing employees, employment contracts containing non-competition clauses are likely to be characterized by a court as invalid and unenforceable.

In Staebler, the Court of Appeal provided a succinct summary of the jurisprudence on this issue:

In short, general principles flowing from Elsley and reiterated in Lyons is that a non-solicitation clause – suitably restrained in temporal and spatial terms – is more likely to represent a reasonable balance of the competing interests and is a non-competition clause. An appropriately limited non-solicitation clause offers protection for an employer without unduly compromising a person’s ability to work in his or her chosen field. A non-competition clause, on the other hand, is enforceable only in exceptional legal circumstances.

In Staebler, the Court of Appeal also noted that, “Elsley makes it clear that a non-solicitation clause is normally sufficient to protect an employer’s proprietary interests and that a non-competition clause is warranted only in exceptional circumstances.” Unless an employee falls within the category of exceptional cases, an employer does not have a proprietary interest in people who are not actual, or potential, customers.

The Court of Appeal’s characterization of the employment agreement at issue in Staebler was consistent with its earlier decision in Lyons v. Multari (2000), 50 O.R.(3d) 526 where MacPherson J.A. summarized Dickson J.’s analysis in Elsley regarding the factors that ought to be considered during a court’s examination of a restrictive covenant in an employment contract:

There are three such factors: first, whether the employer has a proprietary interest entitled to protection; second, whether the temporal or spatial features of the clause are too broad; and, third, whether the covenant is unenforceable as being against competition generally, and not limited to prescribing solicitation of clients of a former employee.

In Lyons, the Court of Appeal also said that a court will not enforce a non-competition clause if a non-solicitation clause adequately protects an employer’s interests. Both Elsley and Staebler contain Viscount Haldane’s implicit warning to solicitors drafting contracts in Mason v. Provident Clothing & Supply Company [1913] A.C. 724 at p. 732

…the question is not whether they could have made a valid agreement but whether the agreement actually made was valid.

In other words, the fact that a clause might have been enforceable had it been drafted in narrower terms will not save it. Prudent solicitors will draft clauses providing evidence of exceptional circumstances justifying a non-competition clause while simultaneously speaking to the reasonableness of the limits of the restrictive covenant in an employment agreement containing a non-competition clause.

The trial judge in Staebler characterized the restrictive covenant as a hybrid non-solicitation and non-competition restrictive covenant and held that it was enforceable. The restrictive covenant in Staebler is below:

In the event of termination of your employment with the company, you undertake that you will not, for a period of 2 consecutive years following said termination, conduct business with any clients or customers of H.L. Staebler Company Limited that were handled or serviced by you at the date of your termination.

The Court of Appeal disagreed with the trial justice’s characterization of Staebler’s restrictive covenant as a hybrid clause:

On the plain reading of the restrictive covenant, it is a non-competition clause. It does nor purport to merely restrain the Employees from soliciting the clients and customers they had served when they worked at Staebler, it prohibits the Employees from “conduct[ing] business” with any such clients or customers.

In Staebler, the Court of Appeal also found that the absence of geographical boundaries combined with a blanket prohibition on conducting business rendered the restrictive covenant “overbroad and unenforceable”, by unreasonably restricting the employee’s economic interests and going beyond that which was reasonably necessary to protect Staebler’s proprietary interest. The Court of Appeal reiterated that a non-solicitation clause is sufficient in conventional employer-employee situations. The employees in Staebler were not managers, directors, or key employees, and did not stand in a fiduciary relationship with their employer.

Although the employees in Staebler had close personal relationships with their clients, their relationships were not exclusive to their clients as other Staebler employees could serve their clients, too. Unlike the circumstances in Elsley, the Court of Appeal observed that Staebler’s employees had “no special knowledge of or influence over the Staebler business whereas Mr. Elsley had control of [the employer’s] trade connections.” In addition to the foregoing, the Court of Appeal noted that there was an imbalance of bargaining power between the employees and their employer in Staebler, while Mr. Elsley “bargained as an equal when selling his business and then carried on as its General Manager.” Similarly, in Valley First Financial Services Limited v. Trach [2004] [B.C.J. No.1127], the British Columbia Court of Appeal held that a suitably-restrictive, non-solicitation clause is likely to be found reasonable for ordinary salespersons in the insurance brokerage industry as opposed to a non-competition clause.

Consequently, most employees who have terminated their employment are not prevented from competing with their former employers but could be subject to post-employment duties relating to the non-solicitation of former employees. Further, a departing employee might be liable for actionable conduct such as the improper use of confidential information, misuse of confidential information as well as duties arising out of their fiduciary duty. For example, in Canadian Aero Service Limited v. O’Malley [1974] S.C.R. 592 Laskin J. noted that under certain circumstances the fiduciary duties of a senior employee remain even after the termination of an employment relationship. Damages for failing to provide reasonable notice of termination could be sought, if an employee failed to provide an employer with appropriate notice of an employment relationship’s termination.

These circumstances were recently examined by the Supreme Court of Canada in a decision involving the departure of all investment advisors at a RBC Dominion Securities Inc. branch to Merrill Lynch at the instigation of the RBC Dominion Securities Inc.’s branch manager. In RBC Dominion Securities Inc. v. Merrill Lynch Canada Inc. et al. [2008] SCC 54, the Supreme Court of Canada held that the RBC employees breached the implied terms of their employment contracts requiring them to provide reasonable notice to their former employer of the employment relationship’s termination; however, it expressly held that the employees were not under a general duty not to compete:

To the extent the trial judge awarded damages on the basis that the employees continued to be under a general duty not to compete, this award of damages was wrong in law.

The Supreme Court upheld the trial judge’s fixing of the notice period at 2.5 weeks taking into account the effect on RBC Dominion Securities Inc. of the simultaneous departure of virtually the entire staff at the branch. Along with being liable for punitive damages, the branch manager who organized the en masse departure to a competitor was also held liable for breaching his contractual duty of good faith – an implied term of the branch manager’s employment agreement.