Restrictive Covenants in Employment Contracts: Non-Competition

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This lecture explains restrictive covenants in an employment contract and specifically explains the enforceability of a non-competition clause.

This lecture is taught by Amer Mushtaq, LL.B., M. Engineering , B.Sc. (Hons.), who is the Principal and Founder of Formative LLP.   Through his YouTube channel, YouCounsel, Amer shares practical advice from his years of legal experience to help anyone access justice and achieve their goals.  Subscribe today to learn more.


Show Notes:


Lecture Slides:

Welcome everyone this is Amer Mushtaq from YouCounsel.

Today we will talk about restrictive covenants in an employment contract.  We will explain to you what a restrictive covenant is; what are different kinds of restrictive covenants that are usually seen in employment contracts.  Then we will specifically talk about non-competition clause in an employment agreement.

This course is not legal advice.  This is only for educational purposes. If you have any specific questions regarding your issues you should contact a lawyer or a paralegal or contact the Law Society of Ontario for a referral.

What is a restrictive covenant?  Very simply a restrictive covenant limits an employee’s ability to do something either during employment or at the end of employment (after employment for a certain period).  It is restricting an employee to do certain acts.  What are those acts?  Those are contained in the specific restrictive covenant that will be in the employee’s contract.  What are some of the common restrictive covenants? The most common one is a non-competition clause.  The other one is a non-solicitation clause which is quite common in employment contracts.  Confidentiality clauses are common in employment contracts.  If you are dealing with any intellectual property of the employer then you may see restrictive covenants relating to intellectual property.

What is the non-competition clause? It simply limits competition with the employer.  If you are an employee, a non-competition clause basically limits your ability to compete with your employer while you are employed and even after your employment has ended either by resignation or even by termination of employment. Most of the non-competition clauses do not talk about non-competition during your employment because that is, sort of, given if you compete against or compete with your employer while you are employed that is simply a breach of your employment contract.  You have an underlying implicit duty to be faithful and loyal to your employer and work in the best interest of your employer.  If you are competing with your employer then that immediately is ground for termination for cause and maybe an action against you for damages.

Most of the non-competition clauses deal with what happens after your employment has ended but essentially what the non-competition clause is doing is limiting an employee’s ability to compete with the employer.

An example that I can give you here is: let’s say that you’re a dentist and you work as an employee or as a dentist for a specific company.  They may have other dentists at that location but you don’t own that business. You are an employee in that business or an independent contractor (in specific circumstances of your case).  Let’s focus on an employment situation.  Let’s say you’re an employee of that dentistry practice.  Your employment contract may contain a non-competition clause that may limit your ability, for example, that once your employment is ended to start your dentistry practice next door or within 500 meters of the previous employer’s dentistry practice. 

The underlying reason obviously, for the employer to have such a clause is that the employer has brought you in – maybe has given you the opportunity to work and learn your skill or refine your skills, interact with customers and whatnot.  Having acquired those skills and having acquired those relationships, the employer does not want you to walk out and then compete with the employer and diminish the employer’s practice.  That’s one of the underlying rationale behind why you may see a non-competition clause in your employment contract.  Non-competition clause is limiting an employee’s ability to compete with the employer in its essence.

What are some of the underlying legal principles with respect to non-competition clauses? Let’s go over these one by one.  The fundamental legal concept that is at play here with respect to non-competition is that there are 2 legal principles: one is freedom of trade.  We, in our democratic and capitalist society encourage competition; we encourage that people are entitled to earn their living in any legal manner that they deem fit and that may include competing with others.  There is the value of trade freedom, of your ability to earn your living the way you would like to, as long as it’s legal.  That’s one of the principles. 

At the same time there’s another legal principle that businesses should be able to protect their legitimate business interests.  One of the legitimate business interests may be that you have hired someone to work for your company, you have trained them, you’ve given them knowledge, or given them ability to meet customers, know your customers and whatnot.  There is a legitimate interest maybe at play for that particular company or employer that you should not walk away and then take away their business. Those are the 2 competing principles that a court is considering when a court is deciding whether to enforce a non-competition clause or not.

With respect to the enforceability of non-competition clauses, I can tell you as of today, April 24th 2019, courts in Ontario and in Canada are extremely reluctant to enforce a non-competition clause.  The general weight of our jurisprudence, as it stands today, is that if there is a non-competition clause the courts generally do not like to enforce.  They will find ways to determine that the clauses are enforceable. Even though the court will rule upon it, remember, that we believe in freedom of contract.  If you have agreed to a contract the court is bound to enforce that contract unless that contract is not in breach of law, in general or a specific statute.  There’s a freedom of contract.  If you agreed to a non-competition clause, you’re agreeing to it. 

For the court to not find it enforceable court has to use some other legal principles rather than saying that even though you signed it we’re not going to enforce it.  No, that’s not the reason why the courts will not enforce it. The court will have to find some other legal principles to say that even though the clause is there we’re not going to enforce the clause in its form because of certain legal principles and we’ll talk about it in our next slide.

Another legal principle for a non-competition clause to be enforceable should be the clause—the way it’s drafted—it should be narrowly drafted; it has to be very clear, there shouldn’t be any vagueness or ambiguity in the clause and the clause should be reasonable.  Those are the 3 things that the court will consider when reviewing a clause for its enforceability.

What is the legal framework when there is a case before a court? –  in which the employer or the former employer of that employee comes to court and says that here is the contract, it was properly signed, was properly executed, it is enforceable and here is a non-competition clause.  We want the court to enforce it because our former employee is now competing with us. What is the legal framework that the court will use to determine whether that clause in forcible or not? Number one, the court will look at the geographical limit in that specific clause.

Let’s take our dentistry example. Imagine for the sake of our example that this specific dentistry practice was based in downtown Toronto. There’s one office/one location based in downtown Toronto. Most of the clients (most of the patients) that come to that dentistry practice are also located in downtown Toronto. That’s how that practice is operating. The non-competition clause says that you, the employee, cannot compete against this dentistry practice anywhere in the GTA—let us say it is nowhere within the Greater Toronto Area can you operate another dentistry in competition with us.

The court will then examine this geographical limit very closely. Remember the underlying principle is if they can find it unenforceable they will try to make it unenforceable.  Is that geographical limit reasonable? Whether it’s clear, number one.  If you say, this is the radius, this is the Greater Toronto Area—whatever the term that you’re using, the court will see whether it’s clear, it’s unambiguous and then whether it’s reasonable.  In this case if most of the business that is coming to that dentistry is within, let’s say, 5 square kilometers in downtown Toronto, then the court will say why is it reasonable for you, the employer to say that you cannot compete against me in the entire GTA.  That’s fundamentally unreasonable. The court may say that there are already let’s say 20 to 30 dentistries that are already in competition with you within the 5 square kilometers and you imposing a limit of 30 to 50 kilometers for the entire GTA is unreasonable.

In that case the court is now closely watching whether the limit that you’re imposing is reasonable to begin with.  If that’s not reasonable as most of your clients are within 5 square kilometer radius, then any limit that is beyond 5 kilometer radius is going to be unreasonable. The court will throw that clause out because the geographical limit is unreasonable.

Then the court will look at the temporal limit—for how long is the employee required not to compete against the employer.  Let’s say in this dentistry practice example: You are the dentist. You work with that dentistry for 5 months but the temporal limit in your non-competition clause says that you cannot compete with that dentistry for 2 years.  Now is that a reasonable time limit with respect to the restraint on your ability to compete with the employer? The court is then going to closely examine what should be an appropriate temporal limit. 

Let me give you an example. If you’re saying that you cannot compete with me for 2 years what you’re saying is that look, even though you know my clients, you know everybody and you know my business in the 4 months that you dealt with, I cannot sustain my business for 2 years if you compete with me.  2 years is a long time.  In some ways that suggests that you are so vulnerable and your ability to keep your clients as your clients is so weak that you know even though that dentist has left you a year ago, you’re still worried that that dentist can take away your client.  Do you even deserve that business because you cannot compete in an open market?  You know there are all these considerations that the court will consider but essentially the court is determining whether the temporal limit that is imposed in the non-competition clause is reasonable and if it’s not reasonable it gets thrown out.  As an employer, you can put in 5 years / 10 years / lifetime or whatever you want but if the temporal limit is not reasonable your clause is not going to get enforced.

Then the 3rd thing that the court is considering is what specific activity or activities are you prohibiting the employee (the former employee) not to do.  What is it that you’re saying you should do / shall not do? One example could be that the clause may say you cannot open another dentistry practice, but what about dental hygienist practice? What if the dentist wants to just open a dental hygienist clinic and not provide services as a dentist but as a dental hygienist or just hire a dental hygienist to provide those services and run that business?  Is that covered in that non-competition clause? Is the dentistry practice the way it’s defined in the contract include dental hygienist practice? If it does, then the question is, is that reasonable? And the court may say no, that may not be reasonable.  This former employee was working as a dentist, never competed with a dental hygienist business and so it is unfair / unreasonable for you to limit the dental hygienist business.  What if the employee just wants to open a shop which sells dental equipment?  Is that in competition?  The court is looking at exactly what is it that the non-competition clause is saying—that the employee cannot do and is that clear; is that reasonable; and if it’s not then the whole non-competition clause gets thrown out.  This is how a court will examine a non-competition clause and then determine whether to enforce that clause or not.

Let’s look at a non-competition clause just for the sake of it.  You can see what kind of non-competition clauses are out there. You may have a similar or somewhat different clause.  There’s no standard language for this.  I just picked one to give you a sense of what a clause can look like.  Here’s a clause:

You will not, for a period of one year (the temporal limit here is one year) following the date of your termination or resignation (it covers termination/dismissal with cause without cause or resignation—in any circumstances), the time period is one year, what is it that you are not allowed to do as an employee—directly or indirectly (key words) in any manner whatsoever including without limitation either individually or in partnership or jointly or in conjunction with any other person or persons as principal, agent, shareholder, associate or in any other manner whatsoever carry on or start your own dentistry practice anywhere within a radius of 10 kilometers of the company’s premises;

And, or directly or indirectly in any manner whatsoever including without limitation work as an agent, associate, employee, independent contractor or in any other manner whatsoever in dentistry practice anywhere within a radius of 10 kilometers of the company’s premises.

This is a pretty strict clause.  It limits your ability to start your practice either directly or indirectly or even work as an agent, associate, employee or any kind of contractor of another dentistry.  Is that cause reasonable? The court is going to look at it and then look at it in minute detail and then determine whether the temporal limit is correct/ is reasonable; whether the geographical limit is reasonable and whether what activities are being prevented is that reasonable?

Another common part of this clause is this: “you acknowledge and agree that the company may apply for or have an injunction.”  Injunction is really that if you start a competing business along with an employer, can the employer literally go to court bring a motion for injunction and stop you right in your tracks? This clause is saying basically that if you do compete with us, we’re going to go bring an injunction against you and then stop you right there and then seek damages for and the legal costs and whatnot. 

Then it further goes on to say, “if any covenant or provision herein is determined to be void or unenforceable, in whole or in part, it shall not be deemed to effect or peril the validity of any of the other covenants or provisions, and such unenforceable or invalid portion shall be severable from the remainder of this agreement.”  This is a typical clause.  If the court finds one clause to be unenforceable the other clauses should continue to be enforceable. “Notwithstanding, the foregoing, if, in any judicial proceeding, any provision hereof is found to be so broad as to be unenforceable, it is hereby agreed that such provisions shall be interpreted to be only so broad as to be enforceable.”

This is trying to say that if the court finds that we put a very broad limit on the geographical scope then whatever interpretation will make it a bit narrower to make it enforceable. Let’s go with that interpretation.  It may not fly in court. But this is the language that you may find in the clause.  And then finally it says that, “you (the employee) acknowledge and agree that all restrictions contained herein are reasonable and valid and all defences to the strict enforcement thereof by the company are waived”.

This is a typical clause and there may be other variations of it. We lawyers spend a lot of time drafting these things because each and every word that is contained in this clause is subject to challenge/is subject to interpretation.  If you want a clause like that to be enforced you have to be very careful in how you draft it and to make sure that it is appropriately drafted so that it could be enforced in court.

In conclusion, what is it that you want remember? It is not easy to enforce non-competition clauses.  Why do we lawyers even put it in the employment contracts when we draft them? Or why do companies put them in those agreements? For a variety of reasons: (1) one reason is simply strategic. It is there as a threat.  You know that there is a clause in there that you’ve signed; it may sound ridiculously broad; It may sound unreasonable but you have signed it.  If you try to compete with the company, we will take you to court.  You will at least, at the end of the day, when you’re before the judge at a trial, you may succeed. But we will drag you into a court fight and you’ll have to spend all this money to prove your case.  That may be a sufficient threat for you to worry about the clause even though when you read it you realize that (based on my lecture) this clause would not have it’s day in court.  At the same time, there are practical implications of getting into a legal fight and you don’t want to be in that situation.

(2)  The other part, if you’re an employee, you want to keep this in mind, this is an important tip for you, when you’re negotiating your employment contract when you see a non-competition clause in your employment contract and you’re a smart guy, you have listened to my lecture and figured out that the clause is not going to be enforceable. Is it even worth it to negotiate with the employer because if it’s a badly drafted non-competition clause, it may be worth for you just to sign it because you know that it’s not going to get enforced. You understand that. If you raise this issue and you say to the employer I don’t want this non-competition clause or the non-competition clause is too broad, then the employer gets into that negotiation and fixes that clause or puts it in a way that is actually going to be enforceable. 

Now you’ve put yourself in a difficult position for the future because now you have not only negotiated a non-competition clause but by raising this issue you have put yourself in a position where the employer has drafted a clause that is actually going to be enforced against you. So you want to be careful even though you read the non-competition clause, you understand it, you’re comfortable that you’re willing to take a risk on this non-competition clause because it’s not going to be enforceable based on how it is drafted—is it even worth to negotiate. Think about that, think about your negotiation power within that deal. If you don’t have negotiation power then you want to be careful about the issues that you raise in an employment contract.

I hope this gives you a sense of what a non-competition clause is; what restrictive covenants are in general. Restrictive covenants are very, very important. Why? Because they limit your ability to do something even when you have left the employment. That’s why when you sign a contract, the most important thing you want to look at is restrictive covenants. What is it that the employer is telling you that you cannot do?  When you have left the employment, you’re not getting paid for that employment, you have to find another job and yet you are bound by an employment contract with a previous employer. Is that something that you want to be worried about? That is something to consider. So restrictive covenants in employment are important. We’ll talk more about this in our future lectures.  We will unpack each and every kind of restrictive covenant and then try to explain them to you in more detail.

Thank-you for watching.

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