Less is More – “Loyalty Incentives” Upheld

Canada’s big five banks and the financial planning industry will benefit by paying close attention to the difference between a “loyalty incentive” and a restraint of trade, as canvassed thoroughly by the Ontario Superior Court in Levinsky v. The Toronto-Dominion Bank, 2013 ONSC 5657.

Levinsky, a managing director with TD Securities Inc., resigned his employment and then challenged the enforceability of the forfeiture provisions in the bank’s Long Term Compensation Plan. Under the plan, Levinsky received Restricted Share Units as part of his compensation, which cliff-vested after three years, i.e. they did not mature until three years after grant, as opposed to other plans under which RSUs vest on a three-year rolling basis. The plan also provided for immediate forfeiture of unvested RSU’s upon resignation.

Levinsky contended that the forfeiture provisions amounted to a restraint of trade, as their intent was to discourage employees from working for a competitor.

The court rejected that argument, finding based on the terms of the plan and other evidence that the plan was designed to incent employee loyalty. As forfeiture was not tied to working for a competitor, the clause at issue did not operate as a restraint of trade.

The decision contains an enlightening and thorough review of authorities from Canada, the UK, Ireland, Singapore, Australia and the U.S. After reviewing these decisions, the court summarized the law as follows:

I conclude that in examining a clause in an employment contract which operates to forfeit deferred compensation upon or following the cessation of the contract, a court must assess whether the clause, on its face or in its practical operation, ties the forfeiture of compensation to the event of termination or whether it ties it to the employee’s conduct following the end of his employment. If the forfeiture results simply from the cessation of the employee’s service, without more, the clause does not operate in restraint of trade because it does not fetter the employee’s ability to choose where he or she wants to work next. Of course, a court must inquire into the circumstances under which the clause came into force to ensure that it was not the product of unfair dealing or bargaining.

Even if the forfeiture results simply from the cessation of employment, the court must examine the terms of the deferred compensation plan to ascertain whether or not the employee possessed any vested rights in the deferred compensation. The forfeiture of vested compensation would necessitate an inquiry into whether the forfeiture constituted a penalty, an analysis similar to that undertaken by Rivard J. in the Nortel Networks v. Jervis case.

(at paras. 81-82)

Applying this law, the court characterized the clause as a form of “loyalty incentive, not a restraint of trade.”

The court also considered whether Levinsky had any vested rights to deferred compensation, noting the forfeiture of vested compensation (even if not a restraint of trade) is still subject to review as to whether the forfeiture constituted a penalty. On this point, the court held that the terms of the plan clearly spelled out that the right to have the value of the RSUs paid out did not vest until three years after the date of grant.

The lesson from this case? Less may be more. While employers may be tempted to combine non-compete clauses with forfeited compensation, doing so will subject such clauses to the traditional reasonableness analysis, whereas forfeiture provisions on their own may be seen as simply “loyalty incentives.”

Arguing Ambiguities in Restrictive Covenants – The Pendulum Swings Back to Enforceability

One of the most-used strategies to argue that a non-compete or non-solicit provision is unenforceable is to point to any possible ambiguity in the wording used.

In the leading Canadian decision, the Supreme Court of Canada held in J.G. Collins Insurance Agencies Ltd. v. Elsley Estate, 1978 CanLII 7 (SCC), that in order to be enforceable, the terms of the restraint must be clear, certain and not vague. In Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6 (CanLII), the Court characterized the demand for clarity as high, finding a clause that prohibited competition in the “Metropolitan City of Vancouver” to be unenforceable, given there was no such legal entity in existence at the time.

Countless restrictive covenants have failed because of the ability of the employee to point to ambiguities in their wording.

In Rhebergen v. Creston Veterinary Clinic, 2014 BCCA 97, the British Columbia Court of Appeal has perhaps swung the pendulum back toward enforceability, holding that a difference of opinion over the meaning of a clause does not necessarily render it ambiguous and hence unenforceable.

As summarized in my earlier article about this decision, the clause at issue in Rhebergen set out economic consequences for a veterinarian if, upon the termination of her contract with a clinic, she were to set up a veterinary practice within three years and within a 25-mile radius in British Columbia.

Specifically, the clause stated:

 NON-COMPETITION

  1. The Associate acknowledges and agrees that she will gain knowledge of and a close working relationship with the CVC’s [Creston Veterinary Clinic Ltd.’s] patients and clients which would injure CVC if made available to a competitor or used for competitive purposes.
  2. The Associate covenants and agrees that in consideration of the investment in her training and the transfer of goodwill by CVC, if at the termination of this contract with CVC she sets up a veterinary practice in Creston, BC or within a twenty-five (25) mile radius in British Columbia of CVC’s place of business in Creston, BC, she will pay CVC the following amounts:

If her practice is set up within one (1) year termination of this contract – $150,000.00;

If her practice is set up within two (2) years termination of this contract – $120,000.00;

If her practice is set up within three (3) years termination of this contract – $90,000.00.

Relying on Elsley and Shafron, the trial judge (2013 BCSC 115 (CanLII)) held the clause to be unenforceable on several grounds, including ambiguity. He considered the words “sets up a veterinary practice” to have a variety of meanings:

In my view, the plaintiff’s concerns are well-founded. “[S]ets up a veterinary practice” can mean a variety of things. Does it prevent the plaintiff from practising veterinary medicine within that radius if her practice is based elsewhere? For example, if her office were outside the 25-mile radius, could she provide services inside the 25-mile radius? Conversely, does the covenant prohibit her from having an office within the 25-mile radius, but only doing veterinary work outside the 25-mile radius? What if she established an office with other veterinarians inside the 25-mile radius but did not personally conduct work within that radius? What if, as the plaintiff has suggested she may do, she seeks to set up a mobile veterinary practice with no specific physical location, but does some work within that radius? What if she joined another practice that started within that radius but did not herself participate in establishing it or “setting it up”?

(at. para. 24)

On appeal, Madam Justice D. Smith for the majority found there was no ambiguity in the clause, noting that differences of opinion on interpretation do not automatically lead to ambiguities. In a portion of the judgment that surely will be cited by many counsel for employers seeking to enforce restrictive covenants in the future, she held:

[74]       A clause is not ambiguous simply because of a difference of opinion as to whether the hypothetical activity triggers the compensable provision. If the clause can be construed by an application of the plain and ordinary meaning of its words and the ordinary rules of grammar, then the clause is not ambiguous. In deciding on the applicability of the contra proferentem doctrine, which is also premised on a finding of ambiguity, Ritchie J., in his concurring reasons in Survey Aircraft Ltd. v. Stevenson, 1962 CanLII 42 (SCC), [1962] S.C.R. 555 at 563, said the following:

In my view the principle was correctly stated by Lord Sumner in London and Lancashire Fire Insurance Company v. Bolands, Limited [[1924] A.C. 836 at 848], and the following language in my opinion has direct application to the present case:

It is suggested further that there is some ambiguity about the proviso, and that, under the various well-known authorities, upon the principle of reading words contra proferentes, we ought to construe this proviso, which is in favour of the insurance company, adversely to them. That, however, is a principle which depends upon there being some ambiguity–that is to say, some choice of an expression–by those who are responsible for putting forward the clause, which leaves one unable to decide which of two meanings is the right one. In the present case it is a question only of construction. There may be some difficulty, there may be even some difference of opinion, about the construction, but it is a question quite capable of being solved by the ordinary rules of grammar, and it appears to me that there is no ground for saying that there is such an ambiguity as would warrant us in reading the clause otherwise than in accordance with its express terms. (The italics are [Ritchie J.’s].)

The Court cited the factual matrix in which the agreement was reached, noting there were no other established veterinary clinics within a 60-mile radius generally or within a 100-mile radius in Canada. Further, the principal source of business for the clinic were the eight dairy herds in the Creston Valley, all of which were situated within the 25-mile radius described in the clause.

The Court concluded by rejecting the hypothetical questions of the trial judge over the meaning of the clause:

In my opinion, the hypothetical scenarios posited by the chambers judge have no basis in the reality of a dairy practice in the Creston Valley.  It matters not, in my view, where on the spectrum Dr. Rhebergen proposes to provide veterinary services within the 25-mile radius of Creston.  If her intention is to provide those services on a regular or continuous basis they will, in my view, trigger the non-competition clause.  That is the only reasonable interpretation that, in my view, could be made on a fair reading of the clause.

(at para. 85)

Economic Disincentives to Compete Found to be Restraints of Trade

The B.C. Court of Appeal’ decision last year in Rhebergen v. Creston Veterinary Clinic, 2014 BCCA 97, is both a win and a loss for employers seeking to restrain employees from competing with them post-employment. In both instances, the decision will have long-reaching effects over employer’s strategies to implement effective restraints and the courts’ decisions on enforceability.

In this, the first of two articles, I will review the Rhebergen’s implications for the use of economic disincentives to compete (as opposed to outright prohibitions). Next week, I will review the Court’s approach to addressing whether a restrictive covenant is ambiguous and therefore unenforceable.

The Facts

The Respondents operated a veterinary clinic in the Creston Valley. The primary business consisted of servicing eight dairy farms in the immediate vicinity. There were no other such clinics within B.C. within a 100-mile radius.

The Appellant graduated from veterinary college and obtained her license. In order to gain practical experience, she applied for work at the clinic and entered in to a three-year “Associate Agreement” under which she was paid $65,000 per year.

The agreement set out particular financial consequences should the Appellant set up a competing practice within three years of the termination of the Agreement. The relevant provisions stated:

  1. NON-COMPETITION
  2. The Associate acknowledges and agrees that she will gain knowledge of and a close working relationship with the CVC’s [Creston Veterinary Clinic Ltd.’s] patients and clients which would injure CVC if made available to a competitor or used for competitive purposes.
  3. The Associate covenants and agrees that in consideration of the investment in her training and the transfer of goodwill by CVC, if at the termination of this contract with CVC she sets up a veterinary practice in Creston, BC or within a twenty-five (25) mile radius in British Columbia of CVC’s place of business in Creston, BC, she will pay CVC the following amounts:

If her practice is set up within one (1) year termination of this contract – $150,000.00;

If her practice is set up within two (2) years termination of this contract – $120,000.00;

If her practice is set up within three (3) years termination of this contract – $90,000.00.

* * *

  1. TERMINATION
  2. CVC agrees not to terminate this agreement during the term hereof except for just cause as hereinafter defined.
  3. The Associate cannot terminate this agreement prior to the expiry of the term, except for death, permanent disability preventing the Associate from continuing to practice veterinary medicine, or default of this agreement by the CVC….

The two principals of the clinic calculated the amount to be paid if the Appellant were to set up a practice within 25 miles of Creston based primarily on their experience in hiring a former associate. They took into account the recoverable and unrecoverable investment made in mentoring, training and equipment and the impact on the clinic’s good will and business if she were to compete for its clientele.

Differences arose between the parties and after 14 months Rhebergen advised she was terminating the agreement and would no longer work for it, whereupon the clinic told her she had no right to terminate the agreement and then proceeded to terminate her employment for cause. Five months later, Rhebergen gave notice that she intended to set up a mobile dairy practice and commenced proceedings seeking to have the section requiring a payment to the clinic declared unenforceable.

Economic Disincentives Considered to be a Restraint of Trade

The trial judge, relying on  Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6 (CanLII), held the clause to be in restraint of trade and unenforceable on several grounds.

At the Court of Appeal, the panel first deal with the issue of whether section 11, not being an outright prohibition on competition, was nonetheless a restraint of trade and therefore unenforceable if unreasonable. The Court noted there are two strands of authority as to whether a clause that creates financial consequences arising from competition, but does not outright prohibit competition, is a restraint:

…there appears to be essentially two strands of authority in the employment context: first, what one may call a ‘functional’ approach, which asks whether the clause at issue attempts to, or effectively does, restrain trade, in which case it will be captured by the doctrine and subjected to reasonableness scrutiny; and second, a more ‘formalist’ approach, in which the clause must be structured as a prohibition against competition to constitute a ‘restraint’.  On the latter approach, mere disincentives to post-employment competition are not sufficient to trigger the doctrine, even if those disincentives operate as effectively at dissuading competitive conduct and participation in the marketplace as a prohibition.

(at para. 28)

Lowry, J.A.,  after reviewing case law in the U.K.,  B.C. and Ontario, held:

 the functionalist approach established in English law is to be preferred as the legal basis for determining whether clauses that burden employees with financial consequences, whether by payment or forfeiture, they would not otherwise have for engaging in post-employment completion constitute a restraint of trade….it is a matter of the effect of the clause in practice over its form.

(at para. 42)

The Court’s decision to adopt the functionalist approach aligns British Columbia with the reasoning of the Ontario Superior Court in Levinsky v. The Toronto-Dominion Bank, 2013 ONSC 5657. Clauses that impose financial consequences for competing post-resignation, such as the “claw-back” of exercised stock options, will only be enforceable if they can be said to be reasonable.

By contrast, in an earlier decision of the Ontario Superior Court, Nortel Networks Corp. v Jervis, 2002 CanLII 49617, the departing employee was sued under a “claw-back clause” which required re-payment of market gains from exercised stock options if he went to work for a competitor within 12 months of exercising the options. The Ontario court held that as Jervis “was not precluded from going elsewhere or from doing whatever he chose to do”, the clause was not a restraint of trade.

Going back to Rhebergen, if “permissive” clauses that allow competition but demand a price constitute restraints of trade, how will they be assessed for reasonableness? Lowry J.A., on behalf of the Court, suggests the amount to be paid, or the amount forfeited “may have to be considered as an element of the fairness of a non-competition clause of that kind.”

Should that be the case, employers will need to carefully weigh the amount of money being forfeited or required to be repaid when insisting on financial consequences if a key employee competes after resigning. While the law of penalties has no application to payments upon the occurrence of an event, i.e. competition, extravagant or unconscionable requirements may cause a court to consider such clauses to be nonetheless unfair and hence unenforceable.

Is Forfeiture of a Bonus for Resigning a Restraint of Trade?

Does the forfeiture of a bonus for leaving an employer constitute a restraint of trade?

This question was recently put to the Ontario Supreme Court of Justice in Levinsky v. TD Bank, 2012 ONSC 5110. The Court’s ultimate response may encourage more employers to require forfeiture or repayment of bonuses to incent employee loyalty as opposed to the use of non-compete clauses.

Enforcement of non-compete clauses in Canada is notoriously difficult. The courts begin from the proposition that the public has an important interest in every person carrying out his or her trade freely, as does the individual. All restrictive covenants are deemed to be restraints of trade, and, without more, are void. An employer, therefore, has the onus of establishing that a non-compete clause is necessary to protect is legitimate proprietary interest.

But what constitutes a restraint of trade? In Levinsky, the applicant contended that a term within a restricted share unit plan that caused him to forfeit $1.75 million in bonuses when he resigned constitutes a restraint of trade and should not be enforced. The plan provides that RSUs do not “fully vest” until three years after they have been allocated and that an employee forfeits his unvested RSUs if he resigns before this date.

(While not stated in the decision, according to the website of Mr. Levinsky’s current firm, he was previously employed by the bank in investment management and, after resigning, co-founded his own investment management firm. I should also note that the opening paragraph of the decision states that the amount at issue is only $174,708, which appears to be a typographical error, as the decision later refers to $1,750,000 being at issue.)

TD Bank argued that the purpose of the plan is to provide “additional” compensation to create “incentives” for employee retention.

Mr. Levinsky proceeded by way of an application instead of by trial. The Court found that he had not provided the appropriate evidence for the court to determine whether or not the provision in dispute is in restraint of trade and, if so, is justifiable, and therefore remitted the matter to the trial list.

While much will obviously depend on the evidence put before the court at trial, prior decisions suggest the court will adopt a more relaxed approach toward enforcement of the forfeiture clause than it would to a non-compete clause.

Indeed, there is considerable question whether the forfeiture clause will be determined to be a restraint of trade at all. In Nortel Networks Corp. v. Jervis, 2002 CanLII 49617 (ON SC), an Ontario Court ordered the defendant, a former Nortel employee, to pay the company more than $625,000 in stock option profits after he joined a competitor.

The terms of the stock option plan stipulated that if, within 12 months (later extended to 24 months) of exercising a stock option, the employee left to join a competitor, Nortel reserved the right to require repayment of the gain.

Jervis exercised options, realized a profit of more than $625,000 and within 12 months left to join a competitor. Nortel sought repayment of the gain.

The court held that this form of clawback provision was not a restraint of trade. Relying on a 1941 decision of the Ontario Court of Appeal in Inglis v. Great West Life Assurance Co., [1941] O.R. 305 (C.A.), the court held that “Where a former employee is required to forego a benefit if he or she chooses to compete, that is not a restraint of trade.” (at para. 29)

Since its release in 2002, Nortel has not received much judicial consideration. Its underlying premise, however, that the foregoing of a benefit if someone chooses to compete is not a restraint of trade, makes good sense. In Levinsky, the particular clause in question in the RSU plan does not even appear to tie the loss of the bonus to competition – the forfeiture takes place merely upon resignation. TD Bank’s argument that the provision is meant to create incentives to promotion employee retention (and not a restraint of trade) is persuasive.

Should Levinksy be decided by the trial court, the decision may provide further support for the use of forfeiture or clawback provisions as an alternative to the use of non-compete clauses.

(Some of the analysis for this argument is taken from an article I wrote, “Protecting Employers from Departing Employees: Alternatives to the Use of Restrictive Covenants”, published in The Advocate, vol. 64, part 1, January 2006, p. 79.)

Failure to Meet Irreparable Harm Test Sinks Both a Non-Solicit and Non-Compete Clause

As predicted earlier in this space, the British Columbia Court of Appeal’s decision in Edward Jones v. Voldeng, 2012 BCCA 295, is making it very difficult to enforce a non-solicit agreement in B.C. on an interim basis pending trial.

In Hub International v. Redcliffe, 2012 BCSC 1280, one of the first decisions to apply Edward Jones, the B.C. Supreme Court refused to enforce a restrictive covenant prior to trial, even though it found there was a strong prima facie case that the provision was enforceable and that the defendant was in breach of it.

The court relied on the decision in Edward Jones to hold that damages should be ascertainable at trial and hence there was no need to enforce the restrictive covenant on an interim basis.

Interestingly, the court characterized the restrictive covenant at issue as a non-solicitation clause and relied on the finding in Edward Jones that damages are more readily ascertainable for breach of non-solicitation clauses than for non-competition clauses.

But from the court’s description of the clause, it appears it was actually both a non-solicitation and non-compete covenant. While the court did not actually quote from the clause, it stated that it:

“…provided a prohibition against soliciting or doing insurance-related business with clients or prospective clients of Hub and Redcliffe Investments. For the former, the period of restriction was 12 months following termination of employment and for the latter 24 months.” 

(at para. 4, emphasis added)

The portion of the covenant preventing the defendant from “doing insurance-related business” with his former employer’s clients is surely a non-compete clause, not a non-solicit provision. A former client could approach the defendant without him soliciting it, yet the defendant would be prevented from doing business with the client. That is a form of a non-compete provision.

The distinction is important, because in Edward Jones the Court of Appeal held that irreparable harm may more readily be found in the case of apparent breach of a non-compete agreement than in the case of a breach of a non-solicit. (I’ve previously written that this distinction is questionable, but nonetheless this is now the law in B.C.) Yet the court in Hub International appears not to have made this distinction and held that the entire clause was unenforceable because the plaintiff could not show irreparable harm.

BC Court of Appeal Raises Bar on Injunctions to Enforce Non-Solicit Clauses

The British Columbia Court of Appeal has raised the bar considerably for employers hoping to obtain an injunction to enforce a non-solicit clause pending trial.

In Edward Jones v. Voldeng, 2012 BCCA 295, released July 3, 2012, the court held that Edward Jones, a securities firm that sought to enforce a six-month non-solicit clause against Voldeng, had not established it would suffer irreparable harm if the interim injunction was not granted.

The decision is one of few Canadian appellate court decisions addressing whether interim injunctions should be granted to restrain alleged breaches of non-solicit and non-compete clauses and hence will be very influential in future cases, particularly in B.C.

Voldeng was subject to a six-month non-solicit provision in his employment contract. He left employment with Edward Jones and took up employment with RBC Dominion Securities. He immediately sent out a communication to his clients announcing his move and indicating he would personally call his clients in coming days to answer any questions they may have.

The B.C. Supreme Court granted an interim injunction, finding, amongst other things, that if the injunction were not granted, Edward Jones could suffer irreparable harm. It also found there was an arguable case that his communication to clients breached the non-solicit clause.

Voldeng sought leave to appeal, obtained it and, remarkably, was able to have his application heard by the Court of Appeal a mere six weeks after the initial order was granted by the Supreme Court.

The Court of Appeal overturned the decision to grant the interim injunction on the basis that Edward Jones had not established it would suffer irreparable harm if the injunction was not granted. In doing so, the Court distinguished a decision by Mr. Justice Groberman, as he then was, in MD Management Limited v. Dhut, 2004 BCSC 513.

In Dhut, Mr. Justice Groberman (who now sits on the Court of Appeal), held that damages would not be an adequate remedy for a breach of a non-solicitation clause by a financial consultant, stating:

I have some sympathy for (the) argument that the arrangements at issue in this case are purely concerned with financial services and that the only losses that might accrue to the plaintiff are financial.  I am, however, not persuaded that damages will prove an adequate remedy.  If the plaintiff succeeds at trial, it will be virtually impossible to unscramble the egg and determine how much the plaintiff lost as a result of violations of the agreement.  Mr. Dhut will argue, as he did before me, that many clients will follow him to ScotiaMcLeod not because of any solicitation but because they value his services.

(at para. 42)

In Voldeng, Mr. Justice Chiasson, on behalf of the Court of Appeal, distinguished Dhut on the basis that in Dhut the client list was provided to the defendant financial advisor by his employer, that the employer was a specialized venture that dealt only with members of the medical profession and that there may have been issues of lost reputation at stake.

The Court did not directly address, however, the passage quoted above addressing the irreparable harm component. Perhaps out of deference to Mr. Justice Groberman, who now sits as a colleague on the Court of Appeal (but was not on this panel), the Court declined to simply say that it disagreed with his decision in Dhut. In my respectful view, it would have been preferable for the Court to do so rather than attempt to distinguish the case on grounds unrelated to the issues raised by Mr. Justice Groberman in the cited passage.

The Court also attempted to distinguish between irreparable harm in the context of a non-solicit agreement and irreparable harm flowing from a non-competition agreement. With respect, the attempted distinction is not persuasive. Here is what the court said about non-solicit agreements:

The respondent asserts that it may not be possible to link a defendant’s breach to damages sustained by a plaintiff.  In my view, in this case, at best, that argument raises an issue of causation; of liability, rather than the difficulty of calculating damages.  The authorities repeatedly have held that difficulty in calculation is not a bar to awarding damages.  Even where irreparable harm is in issue, a plaintiff must establish a link between the conduct of the defendant and potential damages.

(at para. 40)

And here is what the court said about non-competition clauses:

Non-competition covenants restrict a departing employee from seeking business generally.  It usually will not be possible to tell whether business is lost to the employee’s new employer as a result of prohibited competition as opposed to legitimate competition.  Such damages, not being calculable, generally do constitute irreparable harm. 

(at para. 37)

With due respect to the Court, it is difficult to see how the difficulty of proving damages is solely an issue of causation when it comes to non-solicit clauses, but amounts to irreparable harm when it comes to non-competition agreements.

In both cases, there are elements of legally permissible and legally impermissible activity which may each attract clients from the employee’s former employer, making it difficult, in Mr. Justice Groberman’s words from Dhut, to  “unscramble the egg and determine how much the plaintiff lost as a result of violations of the agreement.”

In the case of breach of a non-competition agreement, the new employer’s own business activity (legally permissible) may be the cause of some of the shift in business. In the case of breach of a non-solicit clause, the mere fact of the departing employee leaving to set up business (legally permissible) may in itself, without solicitation, cause a shift in business. Both cases cause difficulty in determining damages but to say that in one case the issue is causation and in the other it amounts to irreparable harm is difficult to accept.

Finally, one wonders if the Court was asked to consider whether it is sending a signal to employers and their legal counsel to use non-compete clauses as opposed to non-solicit clauses. For that likely will be an unintended consequence of this decision.

There is a long line of cases in Canada holding that restrictive covenants should go no further than necessary to restrict an employer’s legitimate proprietary interests. Applying this rule, courts have held that non-compete clauses, being more intrusive on an individual’s right to earn a livelihood, should not be enforced where a non-solicit clause would be sufficient.

Voldeng, it is submitted, may well have the effect of employers inserting non-competition clauses in their employment agreements as opposed to non-solicitation clauses. Given the apparent greater likelihood of the Courts finding irreparable harm for breach of a non-compete agreement as opposed to a non-solicit clause, employers will need to consider including non-compete clauses in their agreements where previously they may have been content with a non-solicit clause.

 

SCC Will Not Have Opportunity to Resolve Questions Raised by Globex Decision

Word out of Alberta that the plaintiff company in Globex Foreign Exchange Corporation v. Kelcher, 2011 ABCA 240, will not be appealing the Alberta Court of Appeal decision to the Supreme Court of Canada. That’s too bad for those of us who had hoped for some clarification from the nation’s top court on some fundamental employment law issues raised by Globex.

 In addition to deciding the issue of whether a restrictive covenant continues to apply to a wrongfully dismissed employee – the issue which has attracted the most attention in legal press – the Court of Appeal also grappled with the question of what, if any, form of consideration is required for introducing a non-compete or non-solicit clause once an employee has commenced employment. Other parts of the decision are good reminders about the importance of careful drafting when it comes to restrictive covenants.

The Background

The case concerned three employees who either, at the commencement of or during the course of their employment with Globex Foreign Exchange Corporation, accepted post-employment restrictions on competing with their former employer or soliciting its clients.

MacLean accepted the restrictions as a term of his initial employment and was wrongfully dismissed. Kelcher and Oliverio agreed to the restrictions during employment but did not receive any new benefits, i.e. “consideration”, for the restrictions. Kelcher and Oliverio left their employment when Globex aske them to accept more onerous restrictions.

The three employees entered into competition against Globex, a foreign currency exchange company. At the Court of Appeal, all three judges agreed that the non-competition clauses were overly broad and hence unenforceable.

The Court sharply differed, however, on the enforceability of the non-solictiation clauses and in doing so raised a number of issues fundamental to the law concerning lawful competition by former employees.

General Billposting Applied – Wrongfully Dismissed Employees Not Subject to Restrictive Covenants

Hunt J.A., writing on behalf of the majority, himself and Martin J.A., applied the English House of Lords decision in General Billposting Co ltd. v. Atkinson, [1909] AC 118, to the effect that a wrongful termination renders restrictive covenants in employment agreements unenforceable. Accordingly, MacLean, who had been wrongfully dismissed, was not bound by his non-solicitation clause.

 The majority would also have found that the clause was both ambiguous and overly broad and would have refused to enforce the clause on those grounds alone.

The majority reviewed prior Alberta decisions and held that General Billposting is still good law in Alberta. The judges also noted that other Canadian appellate courts, including the B.C. Court of Appeal in Poole v. Tomenson Saunders Whitehead Ltd (1987), 16 BCLR (2d) 349 have also followed General Billposting.

The majority declined to deviate from  the General Billposting principle. Amongst other reasons, doing so, it wrote, would reward employers for mistreating employees. For example, an employer could hire a potential competitor, thereafter impose a restrictive coventant, then wrongfully dismiss the employee a short time later but enforce the restrictive covenant.

The court was also concerned that upholding a non-compete or non-solicit clause in respect of a wrongfully dismissed employee would severely constrain that employee’s duty to mitigate his or her damages. 

Slatter J.A. in dissent would not have applied the General Billposting principle. First, he noted that a breach of contract does not automatically terminate the contract. If one party to the contract commits a breach serious enough to evince an intention “not to be bound by the contract”, the other party can accept the repudiation of the contract and terminate it. Such terminatation ends the obligation of either party to perform the substantive or primary covenants, but it does not bring to an end all collateral covenants, e.g. a non-compete clause.

“The argument that a party in breach cannot enforce any other covenant of the agreement is an over extension of the general principle that “the innocent party can accept the repudiation and terminate the contract”. That is true as it relates to the obligation for future performance. But it should not be extended so as to suggest that all the collateral covenants in the agreement have disappeared.” 

(at para. 149)

 

Slatter J.A. also noted that, unlike General Billposting, in Globex the restrictive covenant stipulated that it was to apply for 12 months from the date of termination of employment “for whatever reason” and  hence a dismissal without notice should not affect the enforceability of the clause. 

Finally, Slatter J.A. noted the consequences of a strict application of the General Billposting principle. Suppose an employer misculates the appropriate length of notice by one month and is found at trial to owe one month’s severance. Strictly speaking, a wrongful dismissal has taken place, yet under General Billposting any breach of a restrictive covenant after the dismissal would be excused by virtue of the minor miscalculation.

This aspect of Slatter’s decision has considerable merit to it  – an employer that genuinely attempts to provide reasonable working notice but is slightly off the mark should not lose the benefit of an otherwise valid non-compete or non-solicit clause.

Perhaps the answer lies in the approach followed by the courts in British Columbia when determining whether an employee provided inadequate notice of dismissal is obligated to continue in the position to mitigate damages. The B.C. approach is to determine whether the notice provided was so far off the range of reasonable notice as to signal an intention to no longer be bound by the contract. If the notice provided is far out of the range, a court is more inclined to hold that the employee can repudiate the contract, terminate it and no longer work, without any affect on the duty to mitigate. See, for instance, Giza v. Sechelt School Bus Service Ltd., 2012 BCCA 18.

Adopting the approach of the B.C. courts, an employer that was slightly off the mark in the amount of working notice would not be signalling an intention to no longer by bound by the contract and hence the non-compete or non-solicit clause would still be effective.

Dissenting Judge Questions Requirement of Consideration for Changes to Employment Contracts 

The court also split on whether fresh consideration was required for the enforcement of non-solicit clause introduced during the course of employment. Hunt J.A., for the majority, applied longstanding jurisprudence in Canada that forebearance to dismiss is insufficient consideration. Rather, there must also be a mutual understanding when the restrictive convenant is entered that there will be such forebearance.

Given that Kelcher and Oliviero were already employed and received nothing in return when they accepted the non-solicitation clause, the majority held the clauses were not enforceable. Globex had not made any promise or implied that their employment would continue as a result of their signing.

The concept that some sort of fresh consideration is required to enforce the introduction of a restrictive covenant raises a number of questions. Why are restrictive convenants and some other forms of new employment terms – notably, notice periods – singled out for this treatment while other forms of contract changes are not?

Employers routinely change employment terms throughout the employment relationship, introducing new policies, e.g. restrictions on the use of social media at work, or changing benefit plans or compensation. In the case of some changes, i.e. a change in compensation or a benefit plan, if the employee says nothing and works on under the new circumstances, she is said to condone the change and it becomes part of the employment agreement.

 In the case of a non-compete or non-solicit introduced mid-employment, however, an employee may sign the new agreement and work for several years, yet the concept of condonation or agreement to the change is not applied years later when the employer attempts to enforce the clause.

In a sharp dissent, Slatter J.A. focussed squarely on these issues, stating  “invoking the law of consideration after the fact is the invocation of a legal fiction in aid of a particular result.” (at p. 35)

Slatter J.A. reviewed the Supreme Court of Canada decision in Maguire v. Northland Drug Co., [1935] S.C.R. 412, a decision about the enforceability of a non-compete clause that the employee was asked to sign 11 months after the commencement of employment. The court in Maguire was of the view that the covenant was unenforceable because it was too wide, but otherwise would have held there was adquate consideration given that the “employer tacitly promised that if the bond were signed, the employment would not soon be terminated.” (from Maguire, pp. 415-6, 419)

For Slatter, “Maguire stands, at least, for the proposition that a “tacit promise” that the employment would “not soon be terminated”, followed by an “indefinite refraining” from exercising the right to terminate the employment agreement is sufficient consideration for the covenant.” (at para. 119) “Further, since many of the key terms of employment agreements are implied by law, it is not unreasonable for the law also to imply the “tacit agreement” metioned in Maguire.” (at para. 129)

The majority, by contrast, would require at least a “mutual understanding” that there will be forebearance rather than simply a one-sided “tacit promise.”

Slatter J.A. continued:

“There is nothing unreasonable about either side seeking variations to the terms of an employment agreement from time to time. The employee may seek a raise in pay, or promotion, or transfer, or a different work schedule, or other changes. The employer may feel the need to change the arrangement to respond to competitive pressures or changing business conditions. It is unrealistic to establish a rule of law that prevents the parties to a long-term employment relationship from restating and reducing to writing, from time to time, the terms of employment. Both parties rely on the enforceability of the terms of employment, and should not have their expectations disappointed by an artifical rule of law which makes their covenants unenforceable after they have been relied on for years.”

 (at para. 129)

Slatter J.A. also criticized the Ontario Court of Appeal decision in  Braiden v. La‑Z‑Boy Canada Ltd., 2008 ONCA 464 (CanLII), where the court refused to enforce the notice provision on the basis that it was introduced without consideration, whereas it did enforce a myriad of other changes that hade been made to the employment agreement over its 22-year lifespan. Given this lengthy period, it was not surprising that there were many variations in the employment agreement. However, “of all the changes that were made, the court appears to have found that one (relating to the notice provision) was not enforceable, while many or all of the others (such as those relating to the employee’s duties, his method of pay, the rights to his commissions, and so forth) were implicityly found to be enforceabile. How could there be consideration for some of these changes,m but not others.” (at para. 132)

In my view, the dissent’s reference to promotions, increases in pay or changes in work schedules does not really advance the argument. Where the change is to the benefit of the employee (e.g. a pay raise), that in itself is consideration. Where the change affects the employee immediately (e.g. a change in work schedule) and the employee continues to work, she has condoned the change. And with respect to promotions, an employee very rarely refuses the promotion and hence the change to the contract is not unilateral.

But there may also be instances where changes have been made that are to the detriment of the employee, with no consideration, yet the changes are enforced. A pay cut or a demotion come to mind. Unless the employee, within a reasonable period of time, accepts the repudiation of contract and resigns, he is taken to have condoned the changes. Yet the courts do not apply this same concept to the introduction, mid-employment, of restrictive covenants or defined notice/severance clauses if there has not been consideraton. Why?

I believe the the proper justification for the difference lies in the application of the doctrine of condonation, albeit in a more nuanced manner than is it is traditionally applied. In particular, the focus should be on the ability of the employee to effectively condone a change.

For instance, an employee feels the affect of a unilateral demotion immediately and if the employee continues in the changed position for a resonable period of time, he is taken to have condoned the change. Other unilateral changes that the employee feels immediately would include the loss of a car allowance, a pay cut or a geographic relocation. In all instances, if the employee continues in the position for a reasonable period of time, he has condoned the change.

That is not the case in the instance of the introduction of a restrictive covenant or a defined notice or severance clause. In these instances, the employee does not “feel” the affect of these change until the employment is terminated – perhaps several years later. Hence, it cannot really be said the employee has condoned the change because the change has had no impact on him at the time. 

Thus, I would propose a two-part test to determine whether a unilateral change to the employment agreement should be enforced. First, has their been consideration? Second, if not, has the employee effectively condoned the change, i.e. felt the affect of the change soon after its implementation and nonetheless continued to work? 

Application of this approach may well lead to other changes to the employment contract being held to be unenforceable years later. For instance, an employer unilaterally cancels its long-term disability program and an affected employee continues to work. Years later, the employee becomes disabled but is not covered by a plan. Under the test I propose, the employee would have a claim against the employer for the lost disability plan, given she did not effectively condone its elimination, since she did not immediately feel the affect of it.

Careful Drafting of Covenants Continues to be of Critical Importance

Other aspects of the Globex decision serve as a stark reminder of the importance of precise, careful drafting when it comes to restrictive covenants. Kelcher’s non-solicitation clause stated: 

2. That for a period of twelve (12) months from the date of termination of the Employee’s employment with Globex, for whatever reason, he/she will not, for any reason directly of indirectly as principal, agent, owner, partner, employee, consultant, advisor, shareholder, director or officer or otherwise howsoever, own, operate, be engaged in or connected with or interested in, the operation of or in any way guarantee the debts or obligations of, or have any financial interest in or advance, lend money to, or permit his/her name or any part thereof to be used, or employed in any operation whether a proprietorship, partnership, joint venture, corporation, or other entity, or otherwise carry on, engage in, solicit customers in any manner whosoever, in any business or activity for any client of Globex with which he/she had dealings on behalf of Globex at any time within the twelve (12) months preceding the date upon which the Employee left the employment of Globex.

 (para. 14, with emphasis)

The majority held that the clause was ambiguous and refused to enforce it on this ground. In particular, it found that the term “dealings” was ambiguous both in its meaning and practical application. For instance, if a trader was away from his desk and one of his regular clients called and spoke for a brief period of time to a different trader, would this constitute a “dealing”? And how would the trader who briefly spoke to that client know he had had “dealings” with that client if he didn’t write down the client’s name or make a particular record – something he might not have any motiviation to do if the client was not a regular client of his?

As the majority stated (para. 19), ” If it is impossible to predict when you are breaching a restrictive covenant, it is in essence unreasonable.”

Slatter, J.A., in dissent, did not have the same difficulty with the wording as did the majority:

Just because the word “dealings” might mean different things to different people does not justify the conclusion that it is too vague to mean anything. On that test, no restrictive covenant would ever be enforceable, because any word used will engage conduct at the fringes of its meaning.

(at para. 168)

The majority also found the clause to be over broad because it would prohibit the employee from soliciting in the clients of Globex in any business or activity, even those in which Globex is not involved.