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Restrictive Covenants in a Sale of Business Given Broad Scope

17-Sep-13

By Hugh McPhail, Q.C.

In a decision released on September 12, 2013 the Supreme Court of Canada provided some interesting observations and conclusions in respect of restrictive covenants. The covenant in question arose out of the sale of a business and prevented the vendor’s principal from competing with the purchaser for five years after the end of his consulting employment with the purchaser which followed the sale. This covenant was limited to the province of Quebec. It also contained a non-solicitation agreement which prevented solicitation of both customers and employees of the purchaser for a similar five-year period and that was without geographic limitation.

The Court concluded that, in a sale of business scenario, the onus is on the employee to show that the covenants are unreasonable, as opposed to the employer proving them to be reasonable. It emphasized that courts are much more willing to uphold clauses in a sale situation, as compared with a simple employment situation. On the facts of the case, although the covenant in question was actually part of an employment contract, the motivation for the covenant was found to be the sale of the business. That meant that the more receptive position applied.

What factors did the Court consider relevant in assessing whether the covenants were reasonable? First, it noted: “The factors that can be taken into consideration include the sale price, the nature of the business’s activities, the parties’ experience and expertise and the fact that the parties had access to the services of legal counsel and other professionals.” Secondly, the Court accepted that it was a relevant factor that the agreement in question contained an agreement that the covenant was reasonable.

In the case, the Court put particular emphasis on the nature of the business and its specialized nature because that showed a need for protection from competition. However, in its analysis, the court provided somewhat of a green light for broad covenants with the general observation that: “For example, in the case of a sale of assets between well informed persons who are represented by competent counsel, it is likely, although there may be exceptions, that the clause so negotiated is reasonable.”

Because there was conflicting authority before, it is helpful that the decision also recognized another point. In a recognition of the nature of modern commerce, the Court confirmed that a geographic limitation was not required for an enforceable non-solicitation covenant although a reasonable geographic limit was required for an enforceable non-competition covenant.

The case contains other conclusions that are pertinent to the law of Quebec but these general conclusions by the Court are of assistance and apply to Canada’s common law jurisdictions.

Restrictive covenants have to be carefully drafted so that they provide reasonable protection for a purchaser or they will be void. Each circumstance requires careful assessment. One restriction could be reasonable on certain facts but not in other situations. However, this case provides encouragement for substantial restrictions in sale situations and hope that broad and lengthy covenants will be enforced.

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