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.)

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