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Courts Showing Greater Willingness to Strike Down Restrictive Covenants

11-Jul-11

By Hugh McPhail, Q.C.

A recent unanimous decision of the Ontario Court of Appeal should make some employers nervous about whether their standard restrictive covenants will be enforceable against departing employees. The court was concerned with a restrictive covenant that read:

"I agree that if my employment is terminated for any reason by me or by the Company, I will not, for a period of one year following the termination, directly or indirectly, for my own account or as an employee or agent of any business entity, engage in any business or activity in competition with the Company by providing services or products to, or soliciting business from, any business entity which was a customer of the Company during the period in which I was an employee of the Company, or take any action that will cause the termination of the business relationship between the Company and any customer, or solicit for employment any person employed by the Company. [Emphasis added.]”

The former employee applied to declare that this covenant was unenforceable. He failed at trial but succeeded before a unanimous panel of the Ontario Court of Appeal. Why?

The court looked at the list of three broad factors identified in prior case law: 1) did the employer have a proprietary interest entitled to protection? 2) are the temporal or spatial limits too broad? and 3) is the covenant overly broad in the activity it proscribes because it prohibits competition generally and not just solicitation of the employer’s customers?

The court concluded that the covenant was unreasonable for four reasons:

  1. The confidentiality covenant already provided significant protection for the company. 
  2. “The prohibition on dealing with businesses who may be former customers of the company, whose customer information could be very stale indeed in the case of a 17-year employee, is not consistent with a one year restriction on competition, which then allows the employee to compete freely.”
  3. The employee was in sales for a large company, which operated in a limited sales territory, yet he was prohibited not just from soliciting former customers, but from any dealing with them in competition with the respondent.
  4. In practice, it is not possible for the appellant to know with which potential customers he is prohibited from doing business.”

In the course of the judgment, the court accepted and confirmed that senior executives can be more thoroughly restricted and that restrictions associated with a sale of a business can be more constraining.

One lesson in all of this is that employers should ensure that they don’t restrict employees (especially sales staff) from dealing with all customers but only those that they personally had dealings with. It also signals that courts do not like to uphold broad restrictions on competition. They much prefer restrictions on solicitation of customers. Thirdly, the case recognizes that restrictive covenants ought to be patterned for the particular situation of particular types of employees.

We see this case as one demonstration of a trend in the courts to be more willing to strike down restrictive covenants. They are, after all, only valid if a court thinks they are clear and reasonable.


 

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