Understanding the use of non-competition and non-solicitation clauses and the analysis required to ensure they are enforceable
Businesses often seek to minimise the potential harm that can be inflicted by departing employees. Historically, the law has favoured employee mobility, encouraging free competition in the marketplace and avoiding restraints on the supply of services. It is a longstanding common law principle that covenants that restrain trade are prima facie invalid.
Therefore drafting post-employment restrictions is a task that must be preceded by a careful analysis of facts related to the business, the employee’s duties and responsibilities during the course of employment, and the information and relationships that the employee will have access to as an employee of the business.
Non-Competition vs. Non-Solicitation
While “non-compete” is often used to describe either or both non-competition and non-solicitation, the two terms serve different purposes. Non-compete provisions prohibit former employees from working for or starting a competing business, while non-solicitation clauses prevent former employees from seeking business from the former employer’s clients and/or hiring its employees.
This distinction is important. Non-competes will only be upheld in exceptional cases and are considered invalid by the courts when a non-solicitation clause would have effectively protected the employer’s interests.
In assessing their reasonableness, courts will typically examine the nature of the employee’s position and their relationship with the employer’s client-base.
The purpose of the clause must be limited to the protection of an employer’s “legitimate business interest”. In determining whether an employer has a legitimate interest in protecting itself from a departing employee, it must be recognized that some former employees pose significantly greater competitive threats than others.
For example, while an employer may lawfully restrict the movement of fiduciaries and other senior employees who have been given access to specialized and proprietary information, an employer will rarely have a legitimate business interest in restricting the movement of lower-level employees.
The determination of reasonableness will also vary depending on the nature of the transaction. Post-employment restrictions will be interpreted more favourably in the context of business sales, which are presumed to involve individuals with equal bargaining power. In these circumstances, a promise not to compete or solicit customers is often necessary to protect the goodwill of the business being purchased.
Regardless of whether or not a restrictive covenant arises in a commercial or employment context, when determining the validity of the clause the courts will examine:
- duration of the covenant;
- the territory it covers; and
- the nature of the prohibited activities contained in the covenant.
The covenant must be also drafted in clear and unambiguous language.
The covenant should protect the employer only so long as it is reasonably necessary to recover from the employee’s influence with customers, in the marketplace, or in the technology, as the case may be. Typically, a non-competition or non-solicitation clause should be no more than 12 months, with two years being the outside parameter.
That being said, longer restrictive covenants relating to the purchase of a business may be enforceable. For example, the Supreme Court has held that a five-year non-compete clause was reasonable given the highly specialized nature of the business being purchased.
In general, a narrowly defined area in which the employee is contractually barred from competing with the employer is more likely to withstand the scrutiny of the court. The territory of the restriction must be clearly defined and be no wider than is necessary to protect the employer’s legitimate interests.
With respect to non-solicitation covenants in particular, the Supreme Court has confirmed that in the context of an asset sale the failure to include a territorial limit does not render the non-solicitation clause unreasonable, and it is sufficient that it be limited to target customers.
3. Nature of Prohibited Activities
Not only must an employer have a legitimate business purpose for seeking a restrictive covenant, the covenant must not be overly broad and specifically address the prohibited activity. For example, if the employer’s sole legitimate concern is the solicitation of existing customers, the covenant should only restrict that post-employment activity. A non-competition clause will not be enforced where a non-solicitation clause would have sufficed.
Furthermore, Canadian courts will not read down restrictive covenants containing overly broad provisions to render those covenants enforceable. This is why it is essential that the clause is tailored towards the specific employee, position and business, and the restrictions are drafted narrowly.
Conclusion and Considerations
The absence of an explicit, unambiguous, and reasonable non-competition/ non-solicitation covenant in an employment contract can prove detrimental to an employer. Without such a clause, an employee who is not in a fiduciary relationship with the employer is free to pursue avenues that could have a negative impact on the former employer’s economic interests.
- Some considerations for drafting restrictive covenants include:
- Analysing the business interests the company is seeking to protect.
- If the company is most interested in protecting its relationships with customers or suppliers, identify and define the customers that the employee is likely to have business dealings with.
- If consideration is being given to restricting post-employment activities instead of customer solicitation, look at the employee’s job description and the scope of the employee’s responsibilities.
- Identify the geographic scope of the employee’s business activities: where is the employee going to work?
- Where are the clients the employee will be working with?
Consider whether or not the proposed restrictions will prevent the employee from finding alternate employment in the employee’s chosen field.