Restrictive Covenants - Detailed Analysis

Last Updated: October 2022

5. Employment Contract Attached to Sale of a Business

The courts will apply a less rigorous approach to covenants attached to a sale of a business than one given in a pure employment context, on the assumption that in the former case there is more freedom to contact than in the latter.

This distinction is long-standing. In Shafron v. KRG Insurance Brokers (Western) Inc.1, the Supreme Court of Canada cited with approval the 1894 House of Lords decision in Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co., where Lord Macnaghten wrote:

To a certain extent, different considerations must apply in cases of apprenticeship and cases of that sort, on the one hand, and cases of the sale of a business or dissolution of partnership on the other.  A man is bound an apprentice because he wishes to learn a trade and to practice it.  A man may sell because he is getting too old for the strain and worry of business, or because he wishes for some other reason to retire from business altogether.  Then there is obviously more freedom of contract between buyer and seller than between master and servant or between an employer and a person seeking employment.2

The court noted that while this passage focuses on apprenticeship, “the same concept has been extended and applied to contracts between employers and employees.”3 The court then continued4:

[20]     In the House of Lords’ decision of Herbert Morris, Ltd. v. Saxelby, [1916] 1 A.C. 688, Lord Atkinson made some observations on the difference between contracts of employment and those for sale of a business.  He cited with approval Leather Cloth Co. v. Lorsont (1869), L.R. 9 Eq. 345, at p. 354, quoting James V.C. in that case:

The principle is this: Public policy requires that every man shall be at liberty to work for himself, and shall not be at liberty to deprive himself or the State of his labour, skill, or talent, by any contract that he enters into.  On the other hand, public policy requires that when a man has by skill or by any other means obtained something which he wants to sell, he should be at liberty to sell it in the most advantageous way in the market; and in order to enable him to sell it advantageously in the market it is necessary that he should be able to preclude himself from entering into competition with the purchaser.

Lord Atkinson then stated that “[t]hese considerations in themselves differentiate, in my opinion, the case of the sale of goodwill from the case of master and servant or employer and employee” (p. 701).

The sale of a business often involves a payment to the vendor for goodwill.  In consideration of the goodwill payment, the custom of the business being sold is intended to remain and reside with the purchaser.  As Lord Ashbourne observed at p. 555 of Nordenfelt:

I think it is quite clear that the covenant must be taken as entered into in connection with the sale of the goodwill of the appellant’s business, and that it was entered into with the plain and bona fide object of protecting that business.

And as stated by Dickson J. (as he then was) in Elsley v. J. G. Collins Insurance Agencies Ltd., 1978 CanLII 7 (SCC), [1978] 2 S.C.R. 916, at p. 924:

A person seeking to sell his business might find himself with an unsaleable commodity if denied the right to assure the purchaser that he, the vendor, would not later enter into competition.

See also Burgess v. Industrial Frictions & Supply Co. (1987), 1987 CanLII 2722 (BC CA), 12 B.C.L.R. (2d) 85 (C.A.), per McLachlin J.A. (as she then was), at p. 95.5

More recently, the Supreme Court of Canada again confirmed a “less demanding” approach to assessing the reasonableness of restrictive covenants connected to the sale of a business. Its decision in Payette v. Guay inc, while decided under Quebec civil law, is equally applicable under the common law. The court held 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.  I am therefore of the opinion that, in the commercial context, a restrictive covenant is lawful unless it can be established on a balance of probabilities that its scope is unreasonable.6

At the same time, the court opened the door to a consideration, even within the context of a business transaction, of just how much freedom to contract really existed between the parties when they negotiated the restrictive covenant. It held that, in the commercial context, the circumstances in which the contract containing the restrictive covenant was entered into are relevant to enforceability. These 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 or other professionals. Each case must be considered in light of its specific circumstances.”  The court went on to state it is also necessary to consider the background to the parties’ negotiations, including their level of expertise and experience and the extent of the resources to which they had access at the time of the negotiations.

So far, it appears that the courts have not seized on this passage to create some sort of hybrid test, i.e. a standard falling somewhere between the rigorous standard applied to a covenant in an employment contract as opposed to the more relaxed standard applied to the sale of a business. Rather, the circumstances leading to the business transaction will tip the balance to one approach or the other. Thus, where a covenant purported to restrict the activities of an optometrist, a court rejected the suggestion that because of the relationship between a medical practitioner and her patients, the covenant should be interpreted more like one contained in a purchase-sale agreement and less like one in an employment agreement, finding that there are no “hybrid tests.”7

In a case involving the sale by the son in a father-son dental practice, the court held that the resulting associate agreement in which the father carried on with the practice and covenanted not to compete for a period thereafter should be interpreted within the context of a sale of the business. The father was directly involved in negotiations around his agreement and many, if not most of his demands were accepted. The purchase agreement expressly required him to sign an associate agreement and much of the goodwill in the practice was associated with him.8

In a BC case, a defendant that sold its shares in a business and agreed to a stipulation that it would not “serve or provide advice to” the plaintiff’s customers “for any purpose” argued these terms were ambiguous and also attacked the clause on grounds of overbreadth.

The departing shareholder argued that the term “for any purpose” made the covenant too broad, as it extended the restriction outside the business’s scope of activities, which was selling office furniture and equipment. As such, it was argued the covenant went beyond what was necessary to protect a legitimate proprietary interest.9

The court rejected this argument, finding that:

…put in context and in consideration of the purpose and objective of the restrictive covenant, that to construe “for any purpose” as any possible hypothetical activity, including activities other than the office furniture and equipment business as the defendant suggests, would result in an absurdity. In other words, it would be contrary to any reasonable interpretation of this covenant to find it unreasonable on the basis of a hypothetical concern that does not arise, even remotely, on the facts of this case.10

The court also rejected the other arguments advanced by the defendant and was heavily influenced by the fact that the various covenants arose in the context of a business transaction.

While the existence of a covenant as part of a business transaction will cause the court to apply a less rigorous approach to its enforceability, the covenant nonetheless be unenforceable if the vendor has not fulfilled other aspects of the bargain, such as a promise to employ the vendor.

In a case involving the sale of a refrigeration, air conditioning and furnace repair company, the vendor promised, under the purchase and sale agreement, to offer employment to the owner of the business (and all other employees). The purchaser subsequently reduced the hours of the former owner significantly. The court accepted the vendor’s evidence that he would not have entered into an agreement to work for the purchaser for only part-time work and found that the non-competition agreement became unreasonable when the purchaser failed to provide the vendor with sufficient work.11

In a decision concerning a pharmacist who had retained an employment lawyer to advise on his restrictive covenant with the new owner of the pharmacy, the court noted the evidence showed he had significant bargaining power in his negotiations and used it to his advantage. The court nonetheless held the clause to be ambiguous and unenforceable.12

  1. Shafron v. KRG Insurance Brokers (Western) Inc., [2009] 1 SCR 157, 2009 SCC 6 (CanLII) at para. 19.
  2. Nordenfelt v. Maxim Nordenfelt Guns and Ammunition Co., [1894] A.C. 535 at p. 565
  3. Shafron v. KRG Insurance Brokers (Western) Inc., [2009] 1 SCR 157, 2009 SCC 6 (CanLII) at para. 19.
  4. Shafron v. KRG Insurance Brokers (Western) Inc., [2009] 1 SCR 157, 2009 SCC 6 (CanLII) at para. 20-21.
  5. Burgess v. Indust. Frictions & Supply Co., 1987 CanLII 2722 (BCCA), at para. 25.
  6. Payette v. Guay inc., [2013] 3 SCR 95, 2013 SCC 45 (CanLII), at para. 58.
  7. IRIS The Visual Group Western Canada Inc. v. Park, 2016 BCSC 2059 (CanLII), at paras. 23-24, aff’d 2017 BCCA 301 (CanLII). Note, however, that the court did not address Payette, but instead cited the older Elsley decision. Another Justice of BC Supreme Court, however, contemplated there being a spectrum, and that “cases of commercial agreements between parties of equal bargaining power generally fall at the lower scrutiny end of the spectrum.” 853947 B.C. Ltd. v. Source Office Furniture & Systems Ltd., 2016 BCSC 2233 (CanLII), at para. 36. In another decision involving a small business, the court found that the “inequality of bargaining power” between a small business and a “licensed real estate agent with extensive experience in business marketing” was “less than usually presumed in an employment relationship” which was relevant to the “applicable level of scrutiny” of a non-competition clause. Quick Pass Master Tutorial School Ltd. v Zhao, 2018 BCSC 683 (CanLII) at paras. 35 and 42. 
  8. Parekh et al v. Schecter et al, 2022 ONSC 302, at para. 61.
  9. 853947 B.C. Ltd. v. Source Office Furniture & Systems Ltd., 2016 BCSC 2233 (CanLII).
  10. 853947 B.C. Ltd. v. Source Office Furniture & Systems Ltd., 2016 BCSC 2233 (CanLII), at para. 67.
  11. Powell River Industrial Sheet Metal Contracting Inc. (P.R.I.S.M.) v. Kramchynski, 2016 BCSC 883 (CanLII). Contrast, Smith v. Union of Icelandic Fish Producers Ltd., 2005 NSCA 145 (CanLII), where the purchaser of a fishing business negligently misrepresented to the vendor that there would be a place for him with the business subsequent to the sale. The Nova Scotia Court of Appeal that that covenant was at the heart of the entire purchase and sale transaction and not considered by the parties to be severable. The court referred back to the trial court an assessment of the defendant’s damages for the plaintiff’s breach of the non-competition agreement as well as the plaintiff’s losses for the negligent misrepresentation. There does not appear to have been a consideration of whether the covenant remained reasonable in light of the purchaser’s actions after sale.
  12. M & P Drug Mart Inc. v. Sydney (Alan) Norton, 2021 ONSC 5211, at paras. 16-20.

(a) Restraints of Trade Connected to Arrangements Other than Employment or the Sale of a Business

Some restrictive covenants may be attached to other types of arrangements, such as independent contractor, franchise, agency, partnership or shareholder agreements. The particular circumstances will need to be examined to determine which interpretation should be applied to enforceability, i.e. the Shafron approach to employment contracts or the Payette approach to contracts for the sale of a business.

In a decision concerning an optometric services agreement, the BC Court of Appeal, citing Shafron, held that the threshold question is whether “the agreement contains the elements that support the close scrutiny required of an employment contract, namely, the absence of payment for goodwill and the power imbalance normally present between employee and employer.”1

The court noted that when the optometrist joined the corporation, which sold eye care services and eyewear products, she had been practicing optometry for only four years, had just moved to the community and had no existing patient base. By contrast, the corporation was a large national organization which had been in business for more than 25 years.2 The court went on as follows:

One of the practical indications of a power imbalance is the use of standard form contracts drafted by one of the parties and presented to the other party without any negotiations. The evidence before the trial judge was that “non-competition, non-solicitation and non-disclosure provisions are included in all OSAs” by IRIS. There was no negotiation of these clauses in either agreement between the parties.

The 2010 OSA set the minimum hours of work required of Dr. Park, specified that her weekly schedule had to be approved by IRIS, set vacation days which required approval of IRIS, set the fees that must be charged, and required that upon termination of the agreement all patient files had to be turned over to another IRIS optometrist.

None of the features of a sale of business agreement that supports a more benign scrutiny of a restrictive covenant are present in the circumstances of this case.3

In an earlier decision, the Newfoundland Court of Appeal noted that a courier driver faced an imbalance of bargaining power, despite the parties characterizing him as an independent contractor. Accordingly, application of a high degree of scrutiny to a covenant was justified.4 Similarly, the Manitoba Court of Appeal applied the “rigorous” test as to reasonableness to an auctioneer who worked under an independent contractor agreement.5

In the case of an agency agreement for home heating fuel delivery, the Newfoundland Supreme Court noted that while the restrictive covenant was given in the context of a commercial arrangement, it was a “contract of adhesion” involving no negotiation, i.e. a “take it or leave it” agreement. The court held that the party granting the agency clearly had the upper hand in negotiations, which influenced its interpretation of the covenant. The court further distinguished the facts before it from the authorities dealing with agreements of a commercial nature, which, it found, almost exclusively deal with vendor/purchaser agreements which involve negotiations between equals.6

In arriving at this conclusion, the court noted that the contra proferentem principle applies to contracts of adhesion, i.e. take it or leave it contracts. From here, the court held that in the facts before it, there was no negotiation between the parties as the agent had “no choice but to take it or leave it. In these circumstances the existence of an imbalance in negotiating power…is significant.”7

The courts’ approach to assessing covenants agreed to by employees who buy into the business via a shareholders agreement has not been consistent. Where an employee was offered an opportunity to buy into the business on the basis of executing a shareholders agreement that contained a non-competition clause, the court was not persuaded that 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.8 However, in a more recent decision, an Alberta court applied a more rigorous analysis to such a covenant, despite coming to the conclusion that the evidence did not strongly support an imbalance of bargaining power between the employer and the employee who purchased the shares. Rather, the court, relying on the Supreme Court of Canada’s decision in Payette v. Guay, concluded that the approach applicable to employment contracts applies because of the imbalance that generally exists in all employment relationships.9

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.10

  1. IRIS The Visual Group Western Canada Inc. v. Park, 2017 BCCA 301 (CanLII), at para. 46.
  2. IRIS The Visual Group Western Canada Inc. v. Park, 2017 BCCA 301 (CanLII), at para. 48.
  3. IRIS The Visual Group Western Canada Inc. v. Park, 2017 BCCA 301 (CanLII), at paras. 49-51. 
  4. Dynamex Canada Inc. v. Miller, 1998 CanLII 18094 (NLCA), affirming 1997 CanLII 15963 (NLSCTD), at para. 38.
  5. Winnipeg Livestock Sales Ltd. v. Plewman, 2000 MBCA 60 (CanLII), at paras. 22-24.
  6. Wm. Tapper Ltd. v. Valero Energy Inc., 2017 CanLII 16210 (NL SCTD), at para. 94.
  7. Wm. Tapper Ltd. v. Valero Energy Inc., 2017 CanLII 16210 (NL SCTD), at para. 75.
  8. 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.
  9. 961945 Alberta Ltd (Servicemaster of Edmonton Disaster Restoration) v Meyer, 2018 ABQB 564 (CanLII), at para.  19. The decision may be defensible – and distinguishable –  on the basis of the court accepting the employee’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’s 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, 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.
  10. Ernst v. Stuart, 1993 CanLII 2069 (BCSC) at pp. 14-15, aff’d 1994 CanLII 2426 (BCCA).