Having a written enforceable contract is important as readers of my blog will know primarily because it can limit an employer’s liability for termination without cause by limiting the amount of notice the employee would be entitled  at common law (see related blog on 2016 notice cases).  But there are other important terms in a contract that should not be overlooked especially when employing a senior manager.  In order to protect your business interests all contracts should spell out confidentiality and trade secret obligations.  In certain cases employers may seek to further protect their business through restrictive covenants such as a non-competition clause or a non-solicitation clause.  These provisions can prevent an employee from walking away with your customers and/or setting up shop next door to steal your business.

Unfortunately for employers the courts have made it extremely difficult to enforce such clauses.  They start from the premise that such clauses are illegal restraints of trade and place a heavy onus on employers to prove that the clauses in question were “reasonable” from a legal perspective and necessary to protect legitimate interests:  see Shafron v KRG 2009 SCC 6.

Every now and then a case comes along that provides a very thorough summary of the law in a particular area.  One good example of this is seen in the recent decision in IRIS v Park.

IRIS The Visual Group Western Canada Inc v Park

Dr. Park was employed as an optometrist in Vernon BC.   She signed an employment agreement with respect to her and her company that include a non-competition clause for a term of 3 years preventing her from competing within 5 km of the location she worked in Vernon.  She also agreed not to solicit or entice away anyone “that is in the habit of dealing with [IRIS]” or from soliciting any employees of IRIS.  Further the contract included a liquidated damage clause that quantified what damages are payable upon breach in the amount of $250,000.  Dr. Park resigned and set up business within 5 km of her work location.

The court provided a useful summary of the law “which will guide my analysis of enforceability of the non-competition clause” as follows:

A restrictive covenant in a contract is what the common law refers to as a restraint of trade: Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6 at para. 15.

A covenant in restraint of trade is enforceable only if it is reasonable between the parties and with reference to the public interest: Elsley et al. v. J.G. Collins Insurance Agencies Ltd., [1978] 2 S.C.R. 916 at 923.

… in exceptional cases … the nature of the employment may justify a covenant prohibiting an employee not only from soliciting customers, but also from establishing his own business or working for others so as to be likely to appropriate the employer’s trade connection through his acquaintance with the employer’s customers: Elsley at 926.

Whether a restriction is reasonably required for the protection of the covenantee can only be decided by considering the nature of the covenantee’s business and the nature and character of the employment: Elsley at 926.

… despite the presumption that restrictive covenants are prima facie unenforceable, a reasonable covenant will be upheld: Shafron at para. 17.

The interpretation of restrictive covenants requires the application of different rules depending on whether the covenants are found in commercial agreements or in contracts of employment. These rules will be more generous in the commercial context, but much stricter in the context of contracts of employment or service: Payette v. Guay Inc., 2013 SCC 45 at para. 2.

… the legal framework applicable to contracts of employment takes account of the imbalance of power that generally characterizes an employer-employee relationship, and it is designed to protect employees. In relationships between vendors and purchasers in the commercial context, on the other hand, there is ordinarily – with some exceptions – no such imbalance: Payette at para. 3.

As a general rule, according to Dickson J. in Elsley, at p. 925, the geographic coverage of the covenant and the period of time in which it is effective have been used to determine whether a restrictive covenant is reasonable. The extent of the activity sought to be prohibited is also relevant: Shafron at para. 26.

The agreement sued upon is the employment agreement. It would be wrong, in my opinion, to test that agreement by the criteria applicable in the case of a vendor/purchaser agreement, or by some hybrid test. The restrictive covenant, if enforceable, must stand up to the more rigorous tests applied in an employer/employee context: Elsley at 925.

However, for a determination of reasonableness to be made, the terms of the restrictive covenant must be unambiguous. The reasonableness of a covenant cannot be determined without first establishing the meaning of the covenant. The onus is on the party seeking to enforce the restrictive covenant to show the reasonableness of its terms: Shafron at para. 27.

… if the covenant is ambiguous, in the sense that what is prohibited is not clear as to activity, time, or geography, it is not possible to demonstrate that it is reasonable: Shafron at para. 43.

The court found that Dr Park was in an employment situation and not that of a medical practioner with patients and thus it would analyze the clauses with “with closer scrutiny”.

 

NON-COMPETITION CLAUSE

The court found the non-competition clause was unenforceable because its scope was too broad.  While IRIS had a legitimate interest in its patients who required regular eye examinations and new prescription vision product, it did not have a reasonable interest in protecting its ability to sell nonprescription reading glasses or sunglasses to its patient base.  That made the clause unreasonable and thus it was found to be unenforceable.

This was enough to dispose of the claim but the court went on to comment on the geographic and temporal scope of the non-competition clause.  The court found the 5 km radius and the 3 year term of the prohibition were reasonable based on the evidence.

 

NON-SOLICITATION

As noted the clause referred to clients and patients “in the habit” of dealing with IRIS.  The court held that that meant repetition and further there was no evidence of which patients had “become habituated to the company’s offerings”.  The clause therefore was “so vague as to make enforcement problematic”.  Further the real issue was whether Dr. Park’s advertisements were a breach of the non-solicitation clause.  The court held there was no breach because the ads did not solicit or endeavor to entice away any of IRIS’ patients.

 

LIQUIDATED DAMAGES

 As a preliminary comment the court noted:

But Dr. Park wisely does not argue that she should not be held to the terms of the damages clause based on her cavalier approach to the agreement. I say wisely because Dr. Park is a well-educated person who must take the consequences of signing an agreement without reading it through.

This is an important judicial observation in my view that is often overlooked when an employer tries to hold an employee to the terms of the bargain.

The legal issue here is whether the clause was a genuine pre-estimate of damages in the event of a breach, or a penalty which would not be enforceable.

Again the court provides a useful summary of the law in this area:

Justice Newbury in Maxam Opportunities Fund v. Greenscape Capital Group Inc., 2013 BCCA 460, set out the approach to resolving this issue:

[53]      This court has ruled that the following approach is to be taken to payments that are stipulated to be payable on a breach of contract:

…where the issue is whether a contractual clause is for liquidated damages or is a penalty:

(1)        The question of “penalty” or “liquidated damages” is to be answered as at the date of the making of the agreement;

(2)        If the answer is “liquidated damages”, that is the end of the matter, but, if the answer is “penalty”; then,

(3)        There arises the next question: should relief be granted against the penalty?

(4)        The answer to that question depends upon whether to enforce the penalty would be unconscionable, and that unconscionability has to be determined at the date of the invocation of the clause.

(5)        Sec. 21 [now s. 24] of The Law and Equity Act only applies if and when stage 3 has been reached.

[54]      The Supreme Court of Canada in H.F. Clarke Limited v. Thermidaire Corp. Ltd., [1976] 1 SCR 319, affirmed at 338, that a “sum will be held to be a penalty if it is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach.”

[55]      Similarly, the Court of Appeal in Newman, Hill, Duncan & Lacoursiere v. Murray, 1987 Carswell BC 1103, cited Dunlop Pneumatic Tyre Co. Ltd. v. New Garage and Motor Co. Ltd., [1915] A.C. 79 (H.L.), for the following proposition, at para. 14:

There is a presumption (but no more) that it is a penalty when ‘a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage.’

[56]      The court in Murray at para. 15 also cited with approval the following extract from McGregor on Damages, 14th edition, which is at para. 342 on page 247 of the text:

The same sum cannot in the same agreement be treated as a penalty for some purposes and as liquidated damages for others, for if the same sum is extravagant and unconscionable in relation to one breach to which it applies it cannot be a genuine pre-estimate and the sum becomes branded as having a penal nature which it cannot lose in relation to other more serious breaches to which it also applied. It adds nothing to say that it would not have been a penalty as to the other breach or breaches or that it is the other breach or breaches that have in the event occurred.

Applying these principles the court found the clause to be “extravagant and unconscionable” and therefore it was a penalty and not liquidated damages.  It noted that it must still go on and determine whether it should grant relief against the penalty which hinges on a finding of whether the clause was unconscionable at the date of invocation.  On this point the parties did not provide sufficient evidence on the question of relief against the penalty to decide the issue and thus the court declined to decide whether Dr. Park should be relieved from the penalty. (Bear in mind this issue was obiter because the non-competition clause was found to be unenforceable and therefore Dr. Park had not breached the covenant.)

 

LESSONS LEARNED

 Here are some observations on this case.

  1. Non-competition and non-solicitation provisions are not appropriate or necessary in many cases. In my view they should be used only when a good case can be made for the protection of the employer’s business.
  2. The courts will bend over backwards to find the clauses unenforceable. Therefore if they are important to employers, they should spend sufficient time to analyze what they need.  The clauses should be drafted with the narrowest provisions possible that will provide adequate protection.  And of course they must be clear and unambiguous.
  3. Clauses that are the product of negotiations will more likely be upheld in my view especially where the employee seeks or is offered time to seek legal advice.
  4. Obtaining the evidence to prove a breach is critical. That includes ensuring that computer data is maintained and the employee’s access to the computer information is cut off as soon as possible upon termination.  A strong computer policy should be in place.
  5. Finally the fact that the clause might not ultimately be upheld in court should not necessarily preclude insertion of such a provision in a contract so long as a reasonable argument can be made that it is enforceable. The reality is an employee may not want to engage in litigation where his/her exposure may be significant including legal fees.

 

Michael Weiler practices employment and labour law including human rights and prevention of workplace harassment/bullying and independent investigations; advising on the practical and legal issues affecting private family-owned businesses; and more – see his website at www.WeilerLaw.ca .   Michael is a frequent seminar presenter and the assistant editor of Canadian Cases on Employment Law.  Michael can be contacted at mweiler@weilerlaw.ca  . For those who wish to receive articles, seminar notices and blog comments please contact Carolyn Weiler at cweiler@weilerlaw.ca  or call her at 604 336 7427.

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