Skip to main content

The Truth About Restrictive Covenants

Glen Stratton

Associate
August 17, 2022

Let’s imagine that ‘Jane Smith’ has worked for the same tech company for eight years and during that time developed unique operational systems for the company and built valuable connections with her employer’s clients. Years earlier Jane had signed an employment agreement with a restrictive covenant clause which would prevent her from taking her inside knowledge or strategies of the company to a competing business, should she ever leave.

So, what happens when Jane gets a great offer with a rival company and accepts it?

Can she bring any of the client connections she nurtured at her previous workplace to her new one? Is she able to simply deploy the same systems for her new employer that she helped to create and develop for her previous employer? Can she encourage her former co-workers to take the opportunities available at the new company? Can she do any of these things without the risk of being sued by her former employer?

As with many legal issues, the response is, it depends.

Jane’s situation is the kind that has employers putting restrictive covenant clauses in their employee contracts more often today. Though not entirely foolproof, restrictive covenants are one measure to protect the employer’s proprietary interests or ‘secret sauce’ from being spilled to a competitor. And they can serve as a caution to current or former employees who breach confidentiality before or after leaving the company.

Proprietary Interests

Most claims of proprietary interest concern intelligence such as technology, processes, strategies, clients, confidential information, business relationships and so on. It can take a number of forms and this is why the courts evaluate liability case-by-case.

Employers who seek damages for breach of a restrictive clause can claim on the basis of either ‘non- solicitation’ or ‘non-competition’.

Non-Solicitation

A non-solicitation clause is used to prevent an employee from soliciting the employer’s clients or soliciting other employees to leave the employer. For example, a restrictive clause could be worded this way:

During the term of this Agreement and for twelve (12) months following its termination, JANE SMITH will not, without the prior written consent of COMPANY, either directly or indirectly, on HER own behalf or in the service or on behalf of others, solicit or attempt to solicit, divert, or hire away any person employed by COMPANY or any customer of COMPANY.

Non-Competition

A non-competition clause seeks to prevent an employee from competing with the employer’s business. They are often more difficult to enforce than non-solicitation clauses. For example, the clause may be worded this way:

The Employee, JANE SMITH, shall not, either during his or her employment or for a period of two (2) years following the termination of his or her employment for any reason including resignation, carry on, or be engaged in, or employed by, any person engaged in a business which is the same as, or substantially similar to, or in competition with, COMPANY’S business at the time of any such termination within a radius of eighty (80) kilometres of the City of BLANK.

A non-competition case is more difficult to enforce because the employer must prove that their business was negatively impacted as a direct result of an employee’s breaching the terms of the contract, thereby compromising their proprietary assets in relation to the competition. This is the requirement to prove legal damages.

Non-solicitation cases are enforced more often by the courts because they address specific communications to specific parties (if contracted properly) and the implications are considered less serious than impacting a company’s ability to maintain competitiveness in the market.

Where legally binding, but not easily enforced

Restrictive clauses can only be enforced against an ex-employee where they are put in place to protect the ex-employer’s legitimate business interests and go no further than is reasonably necessary to protect those interests.

So, a restrictive covenant clause filled with ambiguity is often too vague to be enforceable by the courts.

Time and Place

Regarding the departure of our fictional Jane Smith, the geographic location of her previous employer is pertinent for what is necessary to protect her former employer’s business interests.  Any clause defining the market as international would be problematic for the employer to enforce (unless the market is so highly specific that it would exclude all but a handful of other companies in the world – but it is hard to imagine when a court would enforce, even in an ever increasingly global world).

The time window for the duration of the restrictive covenant is usually 6 to 12 months. Of course, the time window will depend on the industry, the employee’s role in the company and the potential for harm to the plaintiff (former employer).

The Case for Enforceable Restrictive Clauses

Restrictive covenant cases are not looked on favourably by courts, as a general rule. Traditionally, courts take the position that most restrictive covenant cases are by their nature unenforceable until proven reasonable.

This is partly because in an employment contract the employer and an employee have unequal bargaining power with respect to negotiating contracts.  Also, importantly, a restrictive clause usually hamstrings an individual’s ability to take advantage of the free- market economy which runs counter to free market principles. They are prohibitive. Courts do not like to actively prohibit individuals or businesses from engaging in conduct.

What is the Test for Enforcing a Restrictive Covenant in the Courts?

The Supreme Court of Canada’s judgement in the seminal case J.G. Collins Insurance Agencies Ltd. v. Elsley Estate provided a test for restrictive covenants in employment contracts, which outlined through three key questions: 

1.         Does the Employer have a proprietary interest entitled to protection?

2.         Is the clause reasonable in terms of duration and geographic scope?

3.         Does the covenant prohibit competition generally or is it limited to barring solicitation of clients of the former employee?

Defining proprietary interest may be a challenge for a complainant as so many businesses within the same industry share similar modes of transaction and marketing. How can the value of the property be assessed and proven to have been negatively affected?

The question becomes; is the duration and geographic scope of a restrictive covenant of a particular contract, reasonable and by what measure? Should a restrictive covenant be in place for months or even years? And how far and wide should the geographic scope be extended?

The current rationale is that the geographic limitations should be linked to time; the greater a geographic area, the shorter the time period should be, or vice versa, the smaller the geographic area, the longer the period of time the clause should be in effect.

Whether you are an employer wanting to protect your business, or an employee wanting to pursue your career with a new company, it is prudent to get the appropriate legal advice in advance and avoid the kinds of mistakes that could lead to a legal tangle.

Employers should be advised of the most effective language in the clause that makes it clear that confidentiality is expected and potentially enforceable in law for a limited period and geographic location. However, it should not be so specific that any deviation from the intent could make the contract unenforceable.

Employees should be aware and cautious that signing a restrictive covenant comes with assuming large responsibilities and to breach a restrictive clause can bring problems that could seriously hamper their smooth transition to new employment and future business opportunities.

Contact us now to discuss restrictive covenants in more detail – we want to help!