November 13, 2009

The Latest Word on Restrictive Covenants in Employment Contracts

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A fundamental concern for many employers is how to prevent former employees from hurting the employer’s business after departure.  To meet this concern, many employers include non-competition, non-solicitation and confidentiality clauses in their employment contracts, collectively referred to as “restrictive covenants”.

Non-Competition Covenants are designed to prevent a former employee from commencing employment with a competitor or starting up his or her own competing business.  Non-Solicitation Covenants are designed to restrict departing employees’ ability to solicit employers’ clients, customers or other employees after they have left the organization. Confidentiality Covenants are designed to protect an employer’s confidential information. Depending on the nature of the business some employers require employees to sign more comprehensive confidentiality agreements, rather than relying on a confidentiality clause in the employment contract. Absent a confidentiality covenant an employee still owes an employer a common law duty not to disclose confidential information belonging to the employer.

There is a heavy burden on an employer seeking to enforce a restrictive covenant to demonstrate that the terms are reasonable, since courts will not enforce an unreasonably broad one.  A court will consider many factors, including the geographic coverage of a covenant, the period of time it will be in effect, and the extent of activity sought to be prohibited in determining whether a restrictive covenant is reasonable or not.

Some employers have tried to increase their chances of being able to enforce a restrictive covenant by listing, for example, a series of ever-shrinking geographical locations in the hopes that a court will, in enforcing the clause, choose the broadest geographical scope reasonable under the circumstances. A recent Supreme Court of Canada decision has clarified that such an approach will not generally be effective.

Shafron v. KRG Insurance Brokers (Western) Inc. 

Earlier this year, the Supreme Court of Canada dealt with the enforceability of restrictive covenants in an employment contract in the case of Shafron v. KRG Insurance Brokers (Western) Inc. This particular case dealt with a non-competition covenant. The central issue in the appeal to the Supreme Court was whether a court should resolve an ambiguous phrase in a non-competition clause by deleting some of the words (a process known as the “doctrine of severance”).  This particular issue arose because the term “Metropolitan City of Vancouver” in the restrictive covenant was not a legally defined term.  The parties disagreed on what was meant by “Metropolitan City of Vancouver” and the Court held the phrase to be ambiguous.

The defendant Shafron had sold the shares of his insurance agency business to KRG Insurance Brokers Inc.  After the sale Shafron continued as an employee of the business. Shafron entered into a contract with the business that contained a non-competition clause. In the contract Shafron agreed that, upon leaving his employment with KRG for any reason except termination without cause, he would not carry on or be employed in connection with the business of insurance brokerage within the “Metropolitan City of Vancouver” for three years.

In December 2000, Shafron left KRG and in January 2001 he began working as an insurance salesman for another agency in the City of Richmond, just outside Vancouver.  KRG commenced an action in the Supreme Court of British Columbia claiming that Shafron was in breach of the restrictive covenant.  The Trial Judge found that the term “Metropolitan City of Vancouver” was neither clear nor certain and was, in addition, unreasonable and therefore unenforceable.  The British Columbia Court of Appeal reversed the Trial Judge’s decision.  The Court of Appeal found, although the term “Metropolitan City of Vancouver” was ambiguous, it was possible to apply the doctrine of “notional severance” to construe it as applying to the City of Vancouver and certain neighbouring municipalities.

The Supreme Court of Canada determined that the terms contained in a restrictive covenant must be unambiguous.  Any ambiguity in terms will make the restrictive covenant unreasonable and therefore unenforceable.

The Court examined the possibility of applying the doctrine of severance to the term “Metropolitan City of Vancouver” in order to give effect to the restrictive covenant.  Severance was examined on the basis of “notional” severance, where a contractual provision is read down to make it enforceable, or through “blue-pencil” severance, where a part of the contractual provision is struck out or removed.

It was determined that a court should be restrained in the application of severance because of the right of parties to freely contract and choose words that determine their obligations and rights.  Because “notional” severance would involve a court rewriting the covenant in a manner it subjectively considered reasonable in each individual case, the Supreme Court of Canada determined that “notional” severance has no place in the construction of restrictive covenants in employment contracts.  The reasons for this finding were, in part, that there is no bright-line test, or clearly defined rule or standard composed of objective factors, for reasonableness.  In addition, the Court found that allowing courts to read down restrictive covenants through “notional” severance would not induce employers to ensure the reasonableness of the covenants in the first place.

The Court found that “blue-pencil” severance could be resorted to in examining restrictive covenants.  However, this form of severance was to be used sparingly and only in cases where the portion being removed is clearly severable, trivial, and not part of the main purport of the restrictive covenant.   In this particular case, the Court found that “blue-pencil” severance could not be applied and the clause was ambiguous and therefore unreasonable and unenforceable.

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