Restrictive Covenants - Detailed Analysis

Last Updated: October 2022

A. Introduction and Overview

The drafting of a restrictive covenant to withstand judicial scrutiny can be a perilous exercise. There are multiple hurdles. A court may refuse to enforce a clause on the basis that it is ambiguous, does not seek to protect a legitimate proprietary interest of the employer or is unreasonable in length, geographic scope or in the nature of activities restricted. If the clause fails the court’s application of the law in any of these areas, the entire clause falls.

At the same time, the lawyer asked to render an opinion to a departing employee on the enforceability of the covenant has many targets at which to aim.

Nonetheless, properly drafted, the restrictive covenant can be a very effective means to protect an employer from certain forms of competition by a departing employee. A prohibition on competition or solicitation, even for a modest period of time, may give the former employer sufficient breathing room to replace the employee, establish new relationships with clients and secure their business.

For the employee, the stakes also can be high. An enforceable restriction on competition or solicitation may dissuade a potential employer from making an offer or effectively hinder the employee from moving clients from one establishment to another.

The restrictive covenant is unlike most other contractual clauses in that, as noted by the Supreme Court of Canada, its very existence in a contract of employment or in an agreement for the sale of a business gives “rise to a tension between the concept of freedom to contract and public policy considerations against restraint of trade.”1

The starting point in the analysis is an assumption that such a covenant, being in restraint of trade, is void, unless the employer can offer something more as to why the court should enforce it. In one of the leading decisions from the Supreme Court of Canada, the court endorsed the House of Lords’ decision in Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co., [1894] A.C. 535. In that decision, Lord McNaughton stated:

The public have an interest in every person’s carrying on his trade freely: so has the individual. All interference with individual liberty of action in trading, and all restraints of trade of themselves, if there is nothing more, are contrary to public policy, and therefore void. That is the general rule.2

At the same time, the common law’s recognition of freedom of contract dictates that there may be exceptions to this rule if the restrictive covenant is reasonable.

This chapter attempts to bring together the case law to provide guidance to counsel tasked with either drafting a restrictive covenant or assessing its enforceability against what Canadian courts deem to be reasonable. Canadian courts have developed a well-known test to determine whether a restraint of trade is enforceable. A court will examine each of the elements described below, in assessing whether the covenant is reasonable. Notably, the covenant must meet each aspect of the test in order to be enforceable.

1. Legitimate Proprietary Interest

The first question to examine is whether the party seeking to enforce the restrictive covenant, i.e. the former employer or the vendor of a business, has a legitimate proprietary interest to protect. In most cases, the only legitimate proprietary interest that may be entitled to protection are the actual or potential customers of the employer.3 Potential customers may include those that the employer had been soliciting within a reasonable period of time prior to termination of the employee.

As the Supreme Court of Canada has stated in Elsley v. J.G. Collins Ins. Agencies, an employer cannot have a proprietary interest in people or entities that are not actual or potential customers, and hence in normal cases a non-competition agreement is not enforceable. Nonetheless, in “exceptional cases”, a non-competition agreement (as opposed to a non-solicitation agreement) may be enforced if the departed employee has a close connection with the employer’s customers so as it make it likely that he or she would appropriate the employer’s trade connection with them. In such cases, a non-solicitation clause would not be sufficient.4

2. Reasonableness Between the Parties

The courts will assess reasonableness between the parties based on the length of the restrictive covenant, its geographic breadth and the nature of the activities restricted. Where a restraint of trade does not actually restrict competition or solicitation, but imposes a financial consequence for engaging in such activity, the BC Court of Appeal has suggested that the amount to be paid or the amount forfeited may need to be considered as part of the overall fairness of the clause.5

3. Reasonable with Reference to the Public Interest

The court also must be satisfied that the restrictive covenant, even if reasonable between the parties, is also reasonable with respect to the public interest. In Elsley, where the Supreme Court of Canada addressed the enforceability of a non-competition clause respecting an insurance salesperson, the court noted there were 20 to 22 general insurance agents in the geographic area, employing 80 to 90 employees and hence no suggestion that the public would suffer through the loss of the defendant’s services in the general insurance business for a period of time.6

4. All Surrounding Circumstances

The Supreme Court of Canada, in Elsley, cautioned that it is important “to resist the inclination to lift a restrictive covenant out of an employment agreement and examine it in a disembodied manner, as if it were some strange scientific specimen under microscopic scrutiny.”7

Such factors as the nature of the business and employment, the surrounding factual matrix and whether the covenant is connected to the sale of business or only to an employment contact often will have a bearing on the interpretation of words argued to be ambiguous, the assessment of reasonableness and the degree of scrutiny applied to the covenant.

5. Employment Contract or Sale of a Business

Case law has drawn a significant distinction between a restrictive covenant which is given as part of the sale of a business by the vendor as opposed to a restrictive covenant existing in a normal employer and employee relationship. In the former case, the employee has received payment for selling the business and has negotiated the restrictive covenant presumably without a significant power imbalance. In such circumstances, the courts will apply a less rigorous scrutiny to the covenant.

In the case of a restrictive covenant in an employment agreement, there will have been no payment made for the sale of business and it is generally accepted that there is an imbalance in power between the employer and employee. Hence, the courts have held that more “rigorous scrutiny of restrictive covenants in employment contracts” is called for than is the case for “those in contracts for the sale of a business.”8

6. Lack of Ambiguity

As the Supreme Court of Canada noted in Shafron, the reasonableness of a restrictive covenant cannot be determined without first establishing its meaning:

The onus is on the party seeking to enforce the restrictive covenant to show the reasonableness of its terms. An ambiguous restrictive covenant will be prima facie unenforceable because the party seeking enforcement will be unable to demonstrate reasonableness in the face of an ambiguity.9

Notably, however, Shafron was decided in the context of an employment contract. The Supreme Court of Canada subsequently stated, in Payette v. Guay, that:

…the criteria for analyzing restrictive covenants in a contract for the sale of assets will be less demanding and that the basis for finding such covenants to be reasonable will be much broader in the commercial context than in the context of a contract of employment.10

This more relaxed approach to interpreting a covenant has been applied in assessing whether particular clauses are ambiguous11

  1. Shafron v. KRG Insurance Brothers (Western) Inc., [2009] 1 SCR 157, 2009 SCC 6 (CanLII), at para. 16.
  2. Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co., [1894] A.C. 535 at p. 565.
  3. Elsley v. J.G. Collins Ins. Agencies, [1978] 2 S.C.R. 916, 1978 CanLII 7.
  4. Elsley v. J.G. Collins Ins. Agencies, [1978] 2 S.C.R. 916, 1978 CanLII 7, at p. 926.
  5. Rhebergen v. Creston Veterinary Clinic, 2014 BCCA 97 (CanLII), at pars. 47-48.
  6. Elsley v. J.G. Collins Ins. Agencies, [1978] 2 S.C.R. 916, 1978 CanLII 7 at pp. 928-29.
  7. Elsley v. J.G. Collins Ins. Agencies, [1978] 2 S.C.R. 916, 1978 CanLII 7 at p. 923-24.
  8. Shafron v. KRG Insurance Brothers (Western) Inc., [2009] 1 SCR 157, 2009 SCC 6 (CanLII) at p. 168. See also Payette v. Guay Inc., [2013] 3 SCR 95, 2013 SCC 45 (CanLII), at p. 110, in which the court held that the same pricniples apply in Quebec under civil law.
  9. Shafron v. KRG Insurance Brothers (Western) Inc., [2009] 1 SCR 157, 2009 SCC 6 (CanLII) at p. 170.
  10. Payette v. Guay inc., [2013] 3 SCR 95, 2013 SCC 45 (CanLII), at para. 58.
  11. See, for instance, 853947 B.C. Ltd., v. Source Office Furniture & Systems Ltd., 2016 B.C.S.C. 2233 (CanLII).