Employee Restrictive Covenants: Another One Bites The Dust
Employers often seek to minimize the harm that employees can inflict upon the business once the employment relationship ends. One common method is the use of post-employment covenants that attempt to restrict an individual’s ability to compete against the employer or solicit the employer’s employees, customers or potential customers.
The Canadian courts have held that although restrictive covenants are considered a restraint of trade and are contrary to public policy, some restrictive covenants will be enforceable in certain circumstances. However, since the threshold for enforceable restrictive covenants is high, those circumstances are often few and far between.
A number of recent decisions have struck down restrictive covenants in which employers attempted to place limits upon the activities of an employee following the end of the employment relationship. In a recent case, Mason v. Chem-Trend Limited, the employer was successful in enforcing a one-year, worldwide restrictive covenant against a former employee, only to have the Ontario Court of Appeal reverse the lower court’s decision.
When Mr. Mason began working for Chem-Trend in 1992, he signed an employment agreement that contained a restrictive covenant that, for the one-year period following the end of the employment relationship, prohibited him from engaging in any business or activity in competition with Chem-Trend by providing services or products to, or soliciting business from, business entities which were customers of the company during his employment. The covenant also prevented him from taking any actions that would cause the termination of the relationship between Chem-Trend and any of its customers or employees. The restrictions applied to the employee’s activities worldwide.
Seventeen years later, Mr. Mason’s employment was terminated by Chem-Trend. Mr. Mason commenced an action for wrongful dismissal and the restrictive covenant was the subject of a separate court application to determine whether and to what extent he was free to compete with Chem-Trend.
The application was initially dismissed by the Ontario Superior Court, which found that given the global nature of Chem-Trend’s business, it was reasonable that the covenant be broad. Mr. Mason appealed to the Ontario Court of Appeal.
The Court of Appeal summarized the principles governing restrictive covenants in employment contracts as follows:
- to be enforceable, the covenant must be reasonable between the parties and with reference to the public interest
- the covenant must balance open competition with the right of an employer to the protection of its trade secrets, confidential information and trade connections; and
- an assessment of the restrictive covenant must consider the context and surrounding circumstances.
Based on these principles, the Court of Appeal identified three factors to be considered:
- Did the employer have a proprietary interest entitled to protection?
- Are the temporal or spatial limits too broad?
- Is the covenant overly broad in the activity it proscribes because it prohibits competition generally and not just solicitation of the employer’s customers?
While the Court of Appeal in Mason agreed with the lower court that the restrictive covenant was unambiguous, it went on to find that the covenant was overly broad. The Court of Appeal noted that Mr. Mason was not a highly placed employee such as a president or chief financial officer, but rather was part of the technical sales force for a large company, who operated in a limited sales territory. The employee was prohibited not just from soliciting former customers, but from dealing with any of them in competition with Chem-Trend. It was also not possible for Mr. Mason to know with which potential customers he was prohibited from doing business, as the restriction was applied to any business entity which was a customer of Chem-Trend during his 17 years of employment with the company.
The Court also noted that Mr. Mason was subject to other post-employment obligations that could protect Chem-Trend, such as prohibitions on the use or disclosure to others of any Chem-Trend trade secrets or confidential information. As a result, the Court of Appeal concluded that the restrictive covenant was unreasonable and unenforceable.
The Court of Appeal’s decision in Mason reinforces the importance for employers to draft restrictive covenants that conform to the general principles and factors that apply to employee restrictive covenants. Employers should also be aware that Canadian courts will not read down or modify an unreasonable restrictive covenant to make it reasonable, but will instead strike it in its entirety. On the other hand, it is worth noting that Mr. Mason was a technical salesperson and not an executive of the company, and the Court of Appeal commented that that there may be more justification for a broader prohibition on competition after highly placed employees such as those in executive positions leave the company.This article was originally prepared for the CA Source, a service for the Canadian Institute of Chartered Accountants and will be appearing in an upcoming issue.