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.