Written by Daniel Standing LL.B., Editor, First Reference Inc.
Generally, a contract in restraint of trade is where one party agrees to restrict their liberty in the future to freely carry on trade with others who are not parties to the contract. Restrictive covenants can take different forms, depending on their purpose. For example, non-competition and non-solicitation covenants aim to prevent a departing employee from setting up a competing enterprise with their former employer. A non-acceptance clause may purport to restrain someone from accepting business from a client of a former employer, and a confidentiality clause normally aims to prevent someone from using information gleaned in one employment context for the benefit of another employer.
When it comes to enforcing a restrictive covenant, consideration of two recent cases from western Canada allows for a brief discussion of the factors that courts rely on to determine the validity of the restrictive covenant. Here are the basic facts of each:
Scenario 1: Dentist A buys Dentist B’s practice in Alberta. Dentist B agrees to continue working with Dentist A for three years. He also agrees that, for the following five years, he will not practice dentistry within a five-kilometre radius of Dentist A’s practice and will not solicit any patients of that practice. Shortly after leaving Dentist A’s practice, Dentist B joins a dental practice across the street. These are the basic facts in Karavos v Smith, 2021 ABQB 714 (CanLII).
Scenario 2: A benefits consultant working for a group benefits and insurance company serviced about 100 clients, most of whom were in Manitoba. Before he quit, he emailed himself a list of his clients and potential clients, along with financial information about them and the services provided to them. After he took a new job with a competing firm, his former employer learned about the email and sought to enforce the confidentiality, non-solicitation, and non-acceptance clauses the parties had agreed to. This case was People Corporation v. Mansbridge, 2021 MBQB 170.
The legal test for granting injunctive relief
In both cases, the former employer sought a form of injunctive relief to protect its interests, based on the contract. There are various types of injunctions but, broadly, it is a discretionary equitable remedy that a court can order to prohibit a party from doing something, or which compels them to do something. The legal test for whether an injunction is appropriate comes from the Supreme Court of Canada’s 1994 decision in RJR-MacDonald Inc. v. Canada (Attorney General), 1994 CanLII 117 (SCC). It requires the party who wants the injunction to prove three things: there is a serious issue to be tried; irreparable harm would result if no injunction were granted, and the ‘balance of convenience’ favours the applicant.
How the courts ruled
In the dentist scenario, the court noted that Dentist B’s agreement not to compete against or take Dentist A’s clients was a commercial restrictive covenant designed to “facilitate the preservation of the goodwill purchased” by Dentist A. As such, it was central to the sale of the business. In drawing a distinction between commercial transactions and employment contracts, the court relied on a 2013 Supreme Court case that held that “parties negotiating the sale of assets have greater freedom of contract than parties negotiating a contract of employment.” Courts give greater scrutiny to restrictive covenants in the latter situation by requiring the applicant to prove they have a “strong prima facie case,” not just a “serious issue,” because those cases do not concern a payment for goodwill, and there is often a bargaining power imbalance between the parties. Turning to the facts, the court viewed the five-kilometre, five-year restriction as being a clear obligation that was reasonable in the context of a business that most patients only visit occasionally. As for Dentist A’s claim that he would suffer irreparable harm without an injunction against Dentist B, the court noted that this factor refers to the nature of the harm, not its magnitude. Injunctions are meant to remedy something that cannot be quantified or fixed with money. Here, the evidence showed that most dental visits cost about $750 but, given that existing patients are often a source of referrals, it was difficult to estimate the anticipated permanent loss of market share. Finally, the court rejected Dr. B’s arguments that the balance of convenience favoured him because the covenants impacted his ability to work, and it would deprive patients of their right to choose a dentist. The court ruled that Dentist B contracted with his eyes wide open, and his patients would just have to drive a bit farther to consult him.
In the benefits case, since the restrictive covenant was found in an employment contract, the court applied the more stringent test, holding that such covenants are prima facie unenforceable and will only be enforced if they are reasonable between the parties and in the public interest. Here, the court determined that all three restrictive clauses were unreasonable and therefore unenforceable. First, it concluded that the confidentiality clause was too broad and ambiguous. The way it was written, it would have covered all information the employee encountered while employed with the company. Instead, the clause should have targeted protecting the former employer’s proprietary interests. Second, the non-solicitation and non-acceptance clauses would have prevented the employee from working with anyone for whom his former employer has or will provide services or products. These were ruled invalid because the employee “cannot reasonably be expected to know who this includes.” The court also found that in the absence of any evidence of client poaching, the former employer failed to prove that it has a strong prima facie case. Despite that failure being determinative, the court also concluded that the former employer failed to prove that it would suffer irreparable harm not compensable in damages if the injunction were not granted. Lastly, the balance of convenience favoured the employee: an injunction would have had devastating consequences for him, cutting off his ability to work in virtually the only industry he had worked in.
When drafting a contract that envisions a form of restraint of trade, no employer can perfectly foresee all possible situations where a former employee could negatively impact its proprietary interests. But as these cases show, the elusive goal of drafting an all-encompassing, watertight contract cannot be achieved with broad or vague language. The employer’s precise intention needs to be reflected in the document using precise language. Otherwise, it will fail for being unreasonable.
Remember, too, that restrictive covenants in employment contracts are subject to increased judicial scrutiny since many such agreements involve parties with unequal bargaining power. Public policy dictates that it is good for people to remain employed, so courts will not allow the employer to pull a fast one on an unassuming employee. However, when the parties to the contract are both sophisticated and the agreement language responds to a precisely articulated and valid concern of the employer, there is a better chance it will be upheld.
The post A Brief Look at Enforcing Restrictive Covenants: A Tale of Two Cases appeared first on Slaw.