Restrictive Covenants in Employment Contracts

What is a Restrictive Covenant in an Employment Contract?

Restrictive covenants often appear in employment contracts where an employer wants to protect its proprietary interests.  Often, a restrictive covenant will take the form of a “non-competition” or “non-solicitation” clause.  Employers will require a prospective employee sign these contracts upon hiring, promotion, or termination.  The goal of restrictive covenants is to prevent a former employee from using the proprietary interests of their former employer, to then solicit customers or clients, or to compete directly against their former employer.  Restrictive covenants are legally binding in Canada.  However, depending on the form that they take, non-competition and non-solicitation clauses may be unenforceable. 

What is the Test for Enforcing a Restrictive Covenant?

The Supreme Court of Canada developed a test to determine whether to uphold a restrictive covenant in an employment contract.  The test was outlined in the seminal case J.G. Collins Insurance Agencies Ltd. v. Elsley Estate[1] and asks three questions: 

1. Does the Employer have a proprietary interest entitled to protection?

   If there is a proprietary interest that may be vulnerable, there may be cause to enforce a restrictive covenant.  Proprietary interests may be confidential information, customer base or business relationships.  Proprietary interests can take a number of forms and thus will be evaluated on a case-by-case basis.

2. Is the clause reasonable in terms of duration and geographic scope?

   The test for a restrictive covenant is “reasonableness”.  There has been a significant amount of case law related to the reasonableness of duration and geographic scope of a restrictive covenant.  Geographic limitations are often linked to temporal limitations; the greater a geographic region, the shorter the temporal period should be.  On the other hand, a longer temporal period will suggest a smaller geographic region.  In at least one case, the Ontario Superior Court of Justice expressed approval of a non-solicitation agreement that didn’t have any geographic restrictions, but where the temporal length of the covenant was reasonable.[2]

3. Does the covenant prohibit competition generally or is it limited to barring solicitation of clients of the former employee?

Courts will treat a non-competition clause different from that of a non-solicitation clause.  The Ontario Court of Appeal in Lyons v Multari stated that “the non-competition clause is a more drastic weapon in the employer’s arsenal”, and that courts will not uphold a non-competition clause where non-solicitation would have sufficed.[3]

Related to the third step of the Elsley analysis is a 4^th consideration, the Court will ask if the covenant is contrary to the public interest.  Restrictive covenants are historically a restraint on trade, which is not kindly looked on by the courts.  A restraint on trade is generally not considered to be in the public interest and thus should be limited in application.  Courts are less likely to enforce a non-competition clause as it can be a restraint on trade, and likewise the content and scope of the prohibited activities in a non-solicitation clause will be vigorously scrutinized.  Where the covenant deprives the public of a badly needed service, it will be found to be unenforceable.[4]

Conclusion

Whether a restrictive covenant will be upheld by the courts is based on whether the covenant itself is “reasonable”, an onus that is placed on the party seeking to enforce it.  Whether a restrictive covenant is “reasonable” will depend on the agreement and all of the surrounding circumstances.  The Supreme Court of Canada, in their most recent case on restrictive covenants (KRG Insurance Brokers (Western) Inc. v. Shafron[5]), held that an ambiguous restrictive covenant will be prima facie unenforceable.  Thus, before applying the Elsley test, it would be prudent to look at the clause objectively to determine if it is ambiguous and thus prima facie unenforceable.

Restrictive covenants in an employment contract are often not favourably looked on by the courts.  This is a direct result of the traditional view that restrictive covenants are a restraint on trade, and that an employer and an employee have unequal bargaining power with respect to negotiating contracts.  With the development of more sophisticated employees in the modern world, this is perhaps a factor that will change into the future.