Non Competition Agreements

Current trends in commercial transactions for the sale of a business are the inclusion of non competition agreements. This blog is prepared to shed light on non competition agreements within a commercial context in respect to the strict reasonableness requirements imposed by the Supreme Court of Canada. Specifically, in regard to the enforceability of restrictive covenants on temporal length and geographic scope in a non-competition agreement. The following provides an overview of the considerations when determining their enforceability.

Restrictive covenants in the commercial context

The Supreme Court of Canada states in Elsley v. J.G. Collins Ins. Agencies Ltd., [1978] 2 S.C.R. 916 that restrictive covenants, by their nature, are contrary to public policy and prima facie unenforceable given they interfere with individual liberty and restrain trade. However, in order to be enforceable, the covenants must not be ambiguous and must be reasonable in terms of spatial and temporal covenants. The restrictions must be reasonable between the parties in light of their interests and within public interest.

Furthermore, the courts have found a distinction to be appreciated between a contract of employment and a contract for the sale of a business where both bargaining powers are equal. That distinction allows for a less strict test in analyzing the lawfulness of restrictive covenants in a commercial context. It goes back to the value behind upholding the freedom to contract in such cases where parties share equal bargaining power. In Rogers Communications Inc. v. Shaw Communities Inc., [2009] O.J. No. 3842, the courts treat the agreement with deference, and it is only in exceptional cases that the courts are justified in over-ruling their own judgment of what is reasonable in their respective interests.

Research indicates that in the sale of a business, it is in the interest of the purchaser to enter into a non-compete. Otherwise, if the vendor cannot assure the purchaser of the business that the vendor will not immediately enter into direct competition with the purchaser, the vendor may find that the business is “unsaleable”. The inherent value of the business in consideration of the payment made by the purchaser is only as strong if it remains and resides with the purchaser.

The courts consider reasonableness through an overall examination of the clause, the agreement in which it is found, and all of the surrounding circumstances. The circumstances include: the sale price; the nature of the business’ activities; the parties’ experience and expertise; and the parties’ access to legal counsel and other professionals. It may be found lawful given that the restrictive covenants are limited to what is reasonably expected for the protection of the legitimate interests of the party in whose favour it was granted.

Following those considerations, the court will then specifically consider the geographic and temporal scope for which the restrictive covenants were drafted.

In Payette v Guay Inc., the Supreme Court of Canada confirmed the interpretation rules applicable to restrictive covenants found in commercial agreements. The Supreme Court judgment concerned restrictive covenants in agreement for sale of assets and a contract for employment. To ensure a smooth transition in operations following the sale, the parties agreed to include a provision in their agreement in which the vendor undertook to work full time for the purchaser as a consultant for six months and a subsequent contract of employment followed. A few years after working for the purchaser, the vendor was dismissed without serious reason and began working for a competitor of the purchaser despite the restrictive covenants in their agreement.

Spatial restrictive covenants

In the context where there is no perceived power imbalance between the vendor and the purchaser in a commercial agreement, the restrictive covenant is given more latitude in order to protect the intention of the parties.

Caselaw provides that where a business cannot, by its nature, be confined to a small area, a restrictive covenant covering a wide geographical area may be reasonable. In the case of Martin v. ConCreate USL Limited Partnership, 2013 ONCA 72, the court upheld the geographic limitation to Canada based on the parties’ reasonable expectations of the scope of the business at the time of the acquisition. In the Court of Appeal judgment, the interested party relied upon evidence of documents that described the operations of the business having reached a national level.

On the other hand, it would not be reasonable to uphold a spatial restriction to Canada-wide where the operations of such business are only focused in Ottawa. A non-competition clause that applies outside the territory in which the business operates is contrary to public order. As mentioned by the majority in Payette, “In principle, the territory to which a non-competition covenant applies is ‘limited to that in which the business being sold carries on its trade or activities… as of the date of the transaction.’”.

When it comes to business of IT nature, it can operate from anywhere. The purchaser in such a business would be inclined to protect its client base from competing with the vendor. The Ontario Superior Court of Justice found that in GDL Solutions Inc. v. Walker, [2012] O.J. No. 3768 that the geographic scope of Ontario was found to be reasonable except for the extension of the coverage to 10 km around Ontario which was found to be difficult to measure. GDL Solutions concerned an IT business in which the clients were found throughout Ontario and certain parts of Quebec, New Brunswick, Alberta and North Carolina. As a result, the Superior Court judge granted the motion for an interlocutory injunction preventing the defendant from breaching the restrictive covenants.

Temporal restrictive covenants

The temporal scope is assessed based on the nature of the activities for which it applies and the specific circumstances including when both parties share equal bargaining power, are well-informed and represented by legal counsel and professionals.

The Supreme Court of Canada provides in Payette v. Guay Inc., [2013] S.C.J. No. 45, that highly specialized in nature business’s activities weigh more in favour of finding a longer period of up to five years to be valid. This was applied in Human Logistics Inc. v. PAL Airlines Ltd., [2018] O.J. No. 6700, in the business of commercial airlines and the Ontario Superior Court of Justice found that the five-year temporal restriction was reasonable. The Ontario Superior Court of Justice in Burns v. Shoppers Drug Mart (London) Ltd. [2000] O.J. No. 874, found that the term of ten years to be reasonable and enforceable based on the interest of the parties, reasonableness, equal bargaining power between the parties and undue interference or influence. In addition, Ross J. for the Alberta Court of Queen’s Bench in Spartek Systems Inc v Brown held that a non- competition agreement on a share sale was lawful where it applied for a period of three years from the closing of the share sale.

As stated above, restrictive covenants must not be ambiguous. In the case of Martin v. ConCreate USL Limited Partnership, the Court of Appeal had a hard time upholding the temporal restriction of five years given that it was dependent on third party consents and began from the date Martin disposed of his units, rather than the date of the sale transaction.

In conclusion, the courts may enforce broad geographic and temporal scopes in non-competition agreements if the purchaser can prove that the restrictions are necessary to protect their interest with regard to the purchase of the company.