Home » Update on Restrictive Covenants: Further Guidance from the Ontario Court of Appeal

Update on Restrictive Covenants: Further Guidance from the Ontario Court of Appeal

by Leanne E. Standryk

Restrictive covenants are intended to restrict and control an individual’s conduct both during and subsequent to the end of a business relationship. Viewed as a restraint on trade/competition and generally considered against public policy, restrictive covenants have been subject to judicial scrutiny and have only been upheld by the Courts where they are reasonable as between the parties and reasonable in light of the broader public interest in discouraging restraints on trade.

In its recent decision in Martin v. ConCreate USL Limited Partnership, the Court of Appeal analyzed a non-competition and non-solicitation clause in the context of a sale of a business. The Court confirmed that restrictive covenants entered into as a part of a commercial transaction, where the parties acknowledged its reasonableness and were represented by counsel, were not beyond judicial scrutiny.

Background: Martin began his career in construction at the age of 18 as a general labourer. He worked for ConCreate and acquired a minority interest in the Company and a related business Steel Design & Fabricators (SDF). ConCreate and SDF were sold to entities controlled by TriWest Construction Limited Partnership at which time Martin obtained 25% of the outstanding limited partnership units of TriWest. As a part of the sale transaction, Martin entered into agreements including an employment agreement containing restrictive covenants together with a non-solicitation, non-competition and confidentiality provision.

The employment agreement included non-competition and non-solicitation covenants prohibiting Martin from carrying on a business competing or soliciting the employees, customers or suppliers of ConCreate or SDF within Canada for 24 months of the date Martin disposed of his partnership. The Partnership agreement included non-competition and non-solicitation covenants which applied for 12 months following the date on which Martin ceased to hold partnership units.

Martin’s employment was terminated 6 months after the sale transaction. He began a competing company 8 days later. ConCreate and SDF brought an action against Martin and his new company claiming breach of the restrictive covenants and his ongoing fiduciary duties and sought damages and injunctive relief. Martin requested a declaration that the restrictive covenants were unenforceable.

The Court of Appeal noted that restrictive covenants are prima facie unenforceable because they interfere with individual liberty and are in restraint of trade. The Court noted that Martin, represented by counsel, had agreed to the covenants in the context of a sale of a business, recognizing the reasonableness of the provisions and that greater deference should be provided to freedom of contract where there is an equality of bargaining power between the two parties. Nonetheless, the Court held that the broader restraints of trade justifiable in the context of a sale of business must be reasonable and that the factors relevant in determining whether the covenants are reasonable in the context of the sale transaction or an employment agreement remain the same: the geographic application, duration, scope of prohibited activity.

The Court of Appeal agreed that the covenant was not ambiguous and that it was reasonable with respect to geographic scope but went on to conclude that it was not reasonable as regards its duration or the scope of the prohibited activities. The duration was unreasonable because it was for an indeterminate period with no fixed limit. The duration was dependent upon Martin’s disposition of his interest in the business which was dependent on the consent of third parties who were unascertainable at the time in which the parties agreed to the covenants and of who owed no duty to Martin to act promptly or reasonably. As to the scope of the prohibited activities, the Court found that the non-solicitation restrictions which extended to any persons who were customers, dealers, agents or distributors, not just at the time of the sale transaction and while Martin was involved with the business but also subsequent to the sale, was too broad. The clause overreached by covering products and activities that the Company did not offer until after Martin ended his involvement with the business.

The Court concluded that the restrictive covenants, non-competition and non-solicitation were unreasonable and therefore unenforceable. In doing so, it reconfirmed some of the established principles used to analyze restrictive covenants. Of specific note is that it took jurisdiction to conduct its own independent analysis of the reasonableness of the covenants despite the parties’ acknowledgement and agreement on this point. Both parties had been represented by legal counsel during the negotiation of the covenants and had agreed that they were reasonable. The Court noted while independent advice and such an acknowledgement were important factors, they will not entirely immunize the clause from scrutiny thereby affirming the strong public interest in discouraging restraints on trade. The Court did uphold the confidentiality provisions noting they were reasonable to protect their intellectual proprietary interests.

Parties negotiating restrictive covenants in the context of any commercial transaction must turn their mind to the reasonableness of the covenants taking into consideration the proprietary interest they seek to protect. Enforceability is fact specific.

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