Employee’s Non-Competition Covenant Attached to Share Purchase Attracts Rigorous Interpretation.

Author: Dean Crawford, KC

961945 Alberta Ltd (Servicemaster of Edmonton Disaster Restoration) v Meyer, 2018 ABQB 564, 2018 ABQB 564

The Alberta Court of Queen’s Bench holds that even where the evidence did not support an imbalance of bargaining power, the more rigorous approach to interpreting restrictive covenants was warranted in respect of a non-competition clause contained within a share purchase agreement.

The characterization of a restrictive covenant as arising from either an employment relationship or a sale of a business is often critical to a court’s assessment of its enforceability. The power imbalance that typically exists between workers and their employers has long been cited as the basis for applying more rigorous scrutiny to covenants arising from employment relationships.

The distinction has been confirmed twice in the last decade by the Supreme Court of Canada, in Shafron v. KRG Insurance Brokers (Western) Inc. [2009] 1 SCR 157, 2009 SCC 6 (CanLII) and Payette v. Guay.  [2013] 3 SCR 95, 2013 SCC 45 (CanLII). In Payette, the Court summarized both the common and civil law position as follows:

[36] The application of different rules in the context of a contract of employment is a response to the imbalance of power that generally characterizes the employer-employee relationship when an individual contract of employment is negotiated, and its purpose is to protect the employee.

[37] These rules have no equivalent in the commercial context, since an imbalance of power is not presumed to exist in a vendor‑purchaser relationship.  The inclusion of non‑competition and non‑solicitation clauses in a contract for the sale of a business is usually intended to protect the purchaser’s investment. …

[39] Thus, the common law rules for restrictive covenants relating to employment do not apply with the same rigour or intensity where the obligations are assumed in the context of a commercial contract.  This is especially true where the evidence shows that the parties negotiated on equal terms and were advised by competent professionals, and that the contract does not create an imbalance between them.

[40] Although Shafron, like Elsley and Doerner, was decided under the common law, the same principles apply in Quebec civil law. …

But what about non-competition or non-solicitation clauses that do not fall neatly into the employment or sale of a business dichotomy? In the past, Canadian courts have focused on whether the power imbalance typically present in the employer-employee relationship was present at the time the covenant was executed.

For example, where an employee was offered an opportunity to buy into a business on the basis of executing a shareholders agreement that contained a non-competition clause, the court was not persuaded the clause should be subjected “to the more rigorous standards traditionally applied to employment agreements.” The court noted that the power imbalances between employer and employee were largely absent in the case. (Audience Communication Inc. v. Sguassero, 2008 CanLII 17306 (ONSC), at para. 34, aff’d Audience Communication Inc. v. Sguassero, 2010 ONCA 510 (CanLII). See also Reservoir Group Partnership v. 1304613 Ontario Ltd., 2007 CanLII 921 (ON SC), at para. 56, where the circumstances of a covenant connected to a partnership agreement were held to more closely resemble those involved in the sale of a business.)

By contrast, where a new partner in a large national accounting practice agreed to a one-year non-competition clause in the partnership agreement, the court found the parties did not have equal bargaining power.  The new party had no ability to influence the provisions of the partnership agreement and had to accept them in order to become a partner.Ernst v. Stuart, 1993 CanLII 2069 (BCSC) at pp. 14-15, aff’d 1994 CanLII 2426 (BCCA).

A recent decision from the Alberta Court of Queen’s Bench, however, departs sharply from this approach. Even though the covenant was not connected to an employment contract and the evidence did not strongly support an inequality of bargaining power, the Court held that the mere fact of employment itself meant the covenant at issue must be subjected to more rigorous scrutiny.

In 961945 Alberta Ltd (Servicemaster of Edmonton Disaster Restoration) v Meyer, 2018 ABQB 564, the former employer, Servicemaster, sought an interlocutory injunction against Meyer for breach of a non-competition covenant. Meyer conceded he was competing, but argued on several grounds that the covenant was not enforceable.

After Meyer had commenced employment, Servicemaster offered him and several other employees the opportunity to purchase shares in Servicemaster’s parent company. He and two other employees did purchase shares, while two other employees did not.

The evidence did not strongly support an imbalance of bargaining power at the time of the share purchase, as the Court noted:

[18] While Meyer did not retain his own legal counsel, he paid for and had access to advice provided by lawyers for other prospective shareholders. There is no evidence that he was pressured into signing by the Applicants. Meyer had the opportunity to review a draft of the ESPA several months before it was signed. He and the other prospective shareholders responded in a memorandum and a meeting, and a number of changes were made to the draft ESPA, including a reduction of the restrictive covenant from three years to two years.

[19] The evidence does not strongly support an imbalance of bargaining power between Meyer and ServiceMaster Edmonton. Meyer was a key employee, who earned a substantial income, and he and the other employees who were offered the opportunity to purchase shares negotiated the terms of the ESPA. …

From here, one would have expected the Court to find that the covenant should be subjected to the less rigorous scrutiny applied to commercial arrangements. The covenant was not part of the initial employment agreement and the employees negotiated, with the assistance of legal counsel, the terms of the covenant. Rather than focus on this specific fact pattern however, the Court instead relied on the power imbalance that generally exists in all employment relationships in deciding to apply more rigorous scrutiny:

[19]…But this, in my view, does not mean that the rules applicable to employment contracts do not apply. Those rules do not depend on a demonstration of duress or unequal bargaining power on a case-specific basis; they apply because of the “imbalance of power that generally characterizes an employer-employee relationship” and in order “to protect employees”: Payette v. Guay inc at para 3, emphasis added. While Meyer may have had a relatively strong bargaining position, he is nonetheless entitled to protection as an employee. He attests that his decision to enter into the ESPA was affected by a concern for his employment. This is not surprising; it is noteworthy that the two employees who did not enter into the ESPA both resigned their employment with ServiceMaster Edmonton soon thereafter. Further, Meyer requires protection upon the termination of his employment. While he may be bound by a reasonable non-competition covenant, his interest in using his acquired skills for the purpose of gainful employment is entitled to due consideration.

The decision may be defensible on the basis of the Court accepting Meyer’s evidence that his decision to executive the shareholder’s agreement was motivated by a concern for his employment. However, to the extent the Court decision suggests that all covenants signed by employees who purchase equity in their employer should attract the more rigorous approach, it is questionable.

Payette, does not invite the courts to treat all such arrangements as covenants related to employment status.  That decision and earlier decisions of the Supreme Court, including Elsley v. J.G. Collins Ins. Agencies, [1978] 2 S.C.R. 916, 1978 CanLII 7, explicitly focused on the power imbalance that is presumed to exist.  Where the facts demonstrate an absence of a power imbalance, such as in a decision to purchase shares in an employer, the Courts should not assume the imbalance exists.

The decision in ServiceMaster also creates the prospect of the courts applying two different standards for interpretation of a restrictive covenant arising from the same shareholder agreement: a rigorous approach if the shareholder is an employee and a lenient approach for non-employee shareholders. (For example, a non-compete clause may be used to prevent a departing non-employee shareholder, who nonetheless has detailed knowledge of client relationships, from competing.) Why should that be the case if neither the employee or the non-employee faced an inequality of bargaining power?

Counsel faced with the task of persuading a court to apply a more lenient approach to the enforcement of restrictive covenants have decisions other than ServiceMaster on which to rely (see discussion in competingemployee.com, Restrictive Covenants, Part 1). However, the ServiceMaster decision is a caution that even covenants attached to shareholder agreements must be drafted with great care and precision, given that a rigorous approach to interpretation may apply if the purchaser of shares is an employee.