Minority Shareholder/Employee Not Bound by Non-Compete Tied to Sale of His Share of the Business
Case comment: ARC Surveys Ltd v Ni, 2024 ABKB 629
The approach of the courts to restrictive covenants attached to the sale of a business, as opposed to those arising solely from employment, is well known. In the case of the former, enforcement is much more likely, with the courts inclined to protect the buyer’s purchase of good will. Not all commercial transactions are the same, however, as evidenced by an Alberta Court’s declaration that a non-compete clause arising from a minority shareholder/employee’s sale of his interest in the business was not enforceable. The decision provides assistance to legal counsel advising minority shareholders/employees or partners in professional services firms on enforceability of such covenants.
A minority shareholder who is also an employee desperately wants out of the business. They agree to sell their interest, resign their employment and be bound by a non-compete and non-solicit clause. What level of scrutiny should apply to those restrictive covenants? The rigorous scrutiny applied to covenants arising from employment contracts or the more relaxed standard applied to those arising from the sale of a business?
In ARC Surveys Ltd v Ni, 2024 ABKB 629, the Alberta Court of King’s Bench adopted a flexible approach, having regard to the circumstances of the sale of the minority shareholder’s interest and the leverage of the purchaser. The Court ultimately declined to enforce a non-compete agreement that otherwise may have been enforced pursuant to a normal sale of business case.
The decision is one of the few that have applied in any depth the Supreme Court of Canada’s reasoning, in Payette v. Guay, 2013 SCC 45, that in the case of a non-compete attached to commercial transaction, the surrounding circumstances leading to that transaction may be considered in assessing enforceability. As stated by the Court in Payette:
[61] In a commercial context, a non‑competition covenant will be found to be reasonable and lawful provided that it is limited, as to its term and to the territory and activities to which it applies, to whatever is necessary for the protection of the legitimate interests of the party in whose favour it was granted… Whether a non‑competition clause is valid in such a context depends on the circumstances in which the contract containing it was entered into. The factors that can be taken into consideration include the sale price, the nature of the business’s activities, the parties’ experience and expertise and the fact that the parties had access to the services of legal counsel and other professionals. Each case must be considered in light of its specific circumstances.
Summary of the Facts
The Defendant Ni was one of the original founders and an employee of Arc Surveys, holding a 39% interest in the business at the outset. The shareholders’ agreement signed in June 2017 provided for payment for share buybacks to be made over two years and that the vendor would be subject to a non-compete for a further two years beyond payment for a total of four. The non-compete covered the City of Calgary.
In 2017, Ni began contemplating selling his shares for a variety of reasons, including the introduction to the company of another employee and shareholder, which diluted his interest.
Discussions for the purchase of his shares commenced in late 2018. Negotiations dragged on. Meanwhile, Ni’s role in the company became more diminished as more work was directed to the new employee. The company also decided not to issue its annual dividend. All of these factors increased the financial pressure on Ni to come an agreement on the sale of his shares.
Negotiations concluded in 2019 pursuant to a share purchase agreement that contained non-compete and non-solicitation restrictions in a schedule. Following the sale, Ni engaged in activities that Arc alleged were in breach of his non-compete covenant.
Arc applied for a permanent injunction against Ni and related defendants to enforce the non-compete, while the Ni defendants cross-applied for a declaration that that the non-compete was of no force or effect.
The Decision
The Court ultimately adopted what may be described as a hybrid approach to the covenants, showing a willingness to delve into the particular circumstances of the transaction, as per Payette, to assess enforceability. The fact that the vendor was only a minority shareholder and also an employee was of importance to the Court:
[32] Although the Agreement is to be analyzed as a commercial agreement, the caselaw regarding non-competition clauses in an employment context can still provide helpful guidelines especially where, as here, there is only a partial sale of the business and by a minority shareholder who is also an employee.
(emphasis added)
From here, the Court reviewed considerations regarding enforceability of non-compete clauses, relying on Ceridian Dayforce Corporation v Daniel Wright, 2017 ONSC 6763, a leading decision on the assessment of non-compete covenants arising from employment relationships.
Notwithstanding its acknowledgment of the “helpful guidelines” from cases in the employment context, the Court was not prepared to apply them entirely. It did not accept the Ni Defendants’ argument that the restriction in the non-compete on having “any financial or other interest” in a business that competes with Arc is ambiguous, despite the existence of decisions which have found that similar restrictions lack clarity.[1]
However, the Court did accept Ni’s argument that the length of the non-compete, a total of seven years, was excessive. In arriving at this finding, the Court’s reasoning is more typical of pure employment cases not connected to the sale of a business.
Important to the court’s ultimate analysis was the evolution of the non-compete clause during negotiations.
In June 2019, Ni and Arc and Arc discussed the sale of shares for $912,600, to be paid to Ni over three annual installments beginning on closing. Arc wanted the non-competition clause to be extended for two years after final payment, for a total of four years.[2]
Arc’s counsel then began drafting the documents. While the purchase price remained the same as the parties had negotiated in June, the non-compete and non-solicit restrictions were drafted to subsist for five years beyond the last payment, for a total of seven years, as opposed to the four years discussed in June. Additionally, the non-compete restrictions were extended to all of Alberta, as opposed to Calgary. These changes were red-lined in a revised agreement, without comment from legal counsel.
Ni nonetheless executed the agreement. While the changes were to his detriment, the Court found that his willingness to execute supported “Ni’s evidence that by August 2019 he was desperate to sell his shares and that Arc had all the bargaining power.”
Ultimately, while the court found that the restrictions on competing and soliciting would be reasonable in and of themselves, the length of the restrictions, seven years, was not. Much of the Court’s reasoning resembles that found in pure employment cases:
[64] A period of seven years is unreasonable under all the circumstances present here.
[65] Ni was an employee and founder of Arc. There was no evidence led that he was essential to running the business, that he had exceptional business talent or experience, or that he was an exceptional draftsperson such that Arc needed to be protected from his talents and connections for a period of over five years.
[66] Further, using the USA as a starting point, there was no consideration offered for the extension of the term of the Agreement.
[67] This was not a purchaser buying the entirety of a business and starting afresh with concern about client retention. There was no transition period required for Arc either corporately or in its operations. Ni’s work could be taken over by Bourgouin, and others could be hired if necessary. Rather than protect its legitimate business interests for a reasonable period of time, the Agreement’s broad wording serves to remove the Ni Defendants from the whole of the municipal surveying business in all of Alberta for a period of seven years. This is punitive personally to Ni, and not a genuine protection required for the continued building of Arc’s business.
Implications
This decision offers important guidance to legal counsel when advising minority shareholders, who were also employees, or departing partners from professional services firms, on enforceability of covenants tied to the sale of their ownership interests. It is one of the first decisions to apply the Supreme Court of Canada’s guidance in Payette that not all commercial transactions are the same and that the circumstances of the transaction should be examined in assessing the enforceability of a non-compete.
[1] See, for instance, IRIS The Visual Group Western Canada Inc. v. Park, 2017 BCCA 301, at para. 63, where court found that language stipulating that the defendant would not be “concerned with” a competing business was ambiguous.
[2] Paragraph 53 of the decision describes the total length as five years, which appears to be an error.