How enforceable are restrictive covenants?

How enforceable are restrictive covenants?

Posted November 14, 2018 Category: Businesses

Restrictive covenants are often included in commercial agreements to provide a limited time for a new or existing business owner to solidify relationships with its customers, suppliers and employees without fear of competition from a current or previous business owner.

Our clients often ask: How enforceable are restrictive covenants?

The answer is…it depends.

The leading case in Canada on the enforceability of restrictive covenants is Payette v. Guay inc., 2013 SCC 45. In that case, the plaintiff purchased the assets of a crane rental company business operated by the defendant, Payette, and his partner for $26 million. The sale agreement provided Payette would be bound by a non-competition clause throughout all of Quebec, and a non-solicitation clause, which did not specify a territory of prohibition. Both were in effect until five years from the date Payette ceased to be employed by the plaintiff.

As is typical, Payette was hired post-sale as a contractor and, later, an employee of the plaintiff for an indefinite term. Payette’s employment was terminated without serious reason. A few months later, Payette and seven of the most experienced employees of the plaintiff were hired by a competitor. The plaintiff obtained court orders to enforce the restrictive covenants against Payette. Payette appealed. The Supreme Court dismissed the appeal.

The Court held the rules applicable to restrictive covenants will differ depending on whether the covenants are linked to a commercial or employment/service agreement. In the commercial context, a restrictive covenant is enforceable unless it can be established on a balance of probabilities that its scope is unreasonable. Although the basis for finding such covenants to be reasonable will be much broader in the commercial context than in the employment context, each case will turn on its own unique circumstances, including such factors as the price paid, the nature of the business activities, the parties’ experience and expertise and whether the parties had access to independent legal advice.

In this case, the Court held that, given the wording and the context in which the restrictive covenants were negotiated, the covenants were linked to the commercial sale and not to the post-sale employment. Hence, Payette had the onus of establishing on a balance of probabilities that the scope of the restrictive covenants were unreasonable. In light of the factors above and the uniqueness of the crane rental industry, the Court concluded that the scope of the restrictive covenants were not unreasonable, and therefore, enforceable.

In light of Payette v. Guay and the cases that have followed it, the drafting solicitor should bear in mind the following to ensure restrictive covenants in a commercial agreement will be legally enforceable:

  • The most aggressive restrictive covenants should separately appear in a
    commercial agreement, such as a shareholders’ agreement where the restrictive
    covenants arise on a sale of the shares – separate and apart from any related
    employment/service agreement(s) (the latter drafted with the advice of an
    employment lawyer!);
  • The commercial agreement(s) in which the restrictive covenants appear should
    clearly identify the source and amount of consideration being paid by the person
    in whose favour the restrictive covenants were granted (i.e. “in consideration of
    the sale of assets”);
  • The scope of the restrictive covenants (in terms of the activities prohibited,
    duration and territory) should be determinable, unambiguous and limited to
    whatever is necessary for the protection of the legitimate interests of the party in
    whose favour they are granted – each case will turn on its own unique
  • The scope of the restrictive covenants, in the case of a non-solicitation clause,
    does not generally require the territory to be defined in order to be enforceable;
  • The scope of the restrictive covenants should not be drafted in a way that confers
    market dominance;
  • The parties should expressly acknowledge the reasonableness of the restrictive
    covenants in the commercial agreement(s) in which they appear (which helps,
    but is not determinative of enforceability);
  • The parties should not deploy a non-competition where only a non-solicitation will
    suffice; and
  • The parties should have an opportunity to obtain or waive independent legal
    advice before agreeing to be bound by any restrictive covenant(s).
Posted November 14, 2018 Category: Businesses

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