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August 5, 2009

Restrictive Covenants Difficult to Enforce

Authors Malcolm MacKillop and Hendrik Nieuwland

Restrictive covenants are often included in employment contracts where an employer has a propriety interest they wish to protect. One type of restrictive covenant is a non-competition clause, which places geographic or temporal restraints on an employee’s ability to work in a competitive business after their employment ends. These covenants can be important to an employer where an employee holds a senior position or possesses sensitive company information.

Courts have made it very clear that restrictive covenants must pass rigorous scrutiny before they will be enforced in an employment context, largely due to the power imbalance that exists between an employer and employee, and the effect restrictive covenants can have on a person’s ability to re-employ.

In the recent case of Morley Shafron v. KRG Insurance Brokers (Western) Inc. (“Shafron”), the Supreme Court of Canada has confirmed that restrictive covenants must be reasonable, clear, and unambiguous in order to be enforced, and that Courts will rarely intervene to cure clauses that are not. Instead, as a general rule, restrictive covenants that are not reasonable, clear, and unambiguous will simply be held unenforceable.

In Shafron, the employment contract stated that the plaintiff could not be employed by any insurance broker post-employment for a period of three years within the “Metropolitan City of Vancouver”. This geographic restraint was found to be ambiguous since there is no common understanding of what “Metropolitan City of Vancouver” encompasses.

The Court took this opportunity to reaffirm various principles relating to covenants. First and foremost, a covenant must be reasonable and the onus is on the party seeking to enforce the restrictive covenant to show that it is reasonable. Particular attention will be paid to the geographic and temporal scope of the clause, as well the activity sought to be prohibited. If any one of these elements are drafted in a manner that is overbroad or otherwise unreasonable, the clause may be found entirely unenforceable.

In order to be reasonable, covenants must be clear and unambiguous. Terms used must be commonly understood by both parties and must not be reasonably capable of more than one meaning. For example, it would likely be unacceptable if a covenant provided that an employee was prohibited from working as a real estate agent for a period of two years in Toronto and the surrounding area, as there is no common definition of what “Toronto and the surrounding area” includes.

The Court confirmed that it will not engage in “blue pencil severance”, which involves striking out a portion of a covenant in order to resolve an ambiguity or cure a drafting default, except in rare cases where the portion to be removed is clearly severable, trivial and not part of the main purpose of the restrictive covenant. A Court would therefore be unlikely to remove “and the surrounding area” from the previous example so that the employee is prohibited from working in “Toronto”. Geography is a main component of the covenant, and altering it would change what the parties bargained.

The Court also confirmed that it is not appropriate to apply “notional severance”, also referred to as “reading down”, in order to make a clause legal and enforceable. For example, a Court will not impose its own view and read down the clause to mean “Toronto, Etobicoke and Scarborough” as opposed to the many other possible variations.

In the Shafron case, the Court found the term “Metropolitan City of Vancouver” ambiguous. It determined that blue pencil severance could not cure the covenant because removing the word “Metropolitan” would change a main component of the contract that the parties had bargained. The Court also determined that notional severance, applied by the Court of Appeal in this matter who read down the covenant to read “the City of Vancouver, the University of British Columbia Endowment Lands, Richmond, and Burnaby”, should not be applied to restrictive covenants. (The Court also determined that this was not an appropriate case for rectification, as it was not clear the parties had ever been of the same mind with respect to the geographical scope of the covenant.) The decision of the trial judge was therefore restored and the covenant was found entirely unenforceable.

What to take away
Some important points for an employer to remember when drafting restrictive covenants are as follows:

1. Make sure the language is clear and unambiguous. Ensure that both parties specifically agree on what the language means before executing.
2. Make sure the restrictions imposed are reasonable and not overreaching. Define the description of the competitive business the employee is prohibited from joining, the geographic scope, and the temporal scope as narrowly as possible.
3. Tailor restrictive covenants to each individual employee based on their particular circumstances. There is no “one size fits all”.
4. Seek legal advice regarding the enforceability of a restrictive covenant prior to entering any agreement.

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