The Perils in Drafting Restrictive Covenants and the Importance of Context
Ceridian Dayforce Corporation v. Daniel Wright (2017 ONSC 6763),
853947 B.C. Ltd. v. Source Office Furniture & Systems Ltd. (2016 BCSC 2233)
A recent decision of the Ontario Superior Court of Justice refusing to enforce a non-competition clause highlights the many ways in which the drafter of a restrictive covenant can go too far in attempting to protect the interests of a business from its departing employees.
In Ceridian Dayforce Corporation v. Daniel Wright (2017 ONSC 6763), the court declared a non-competition clause unenforceable, finding no less than eight faults with it. Given that the clause likely would have fallen even if the court had found only one fault, the decision is a stark reminder that the drafting of a restrictive covenant to withstand judicial scrutiny can be a perilous exercise.
The decision also stands as an interesting counterpoint to a 2016 decision of the BC Supreme Court. Faced with similar objections to the restrictive covenants at issue in that case, the court in 853947 B.C. Ltd. v. Source Office Furniture & Systems Ltd. (2016 BCSC 2233) (“Source Office Furniture”) enforced the covenants. Context was critical in the two decisions, however, as the court in Ceridian was faced with a non-compete clause given by an employee, whereas in Source the restrictive covenants were tied to the sale of a business.
The individual defendant in this case was a software developer, formerly employed by the plaintiff corporation in designing, building and testing components of its software. At the outset of his employment, he executed an agreement containing a non-compete clause. He resigned five years later and soon thereafter took up employment with a competitor.
The plaintiff corporation invoked the non-compete clause, attempting to justify it on the basis that the knowledge held by the employee was unique such that a non-solicitation or confidentiality provision was insufficient to protect its trade secrets relating to its software. It argued that the information to be protected was in the employee’s “head”. The plaintiff corporation brought a partial summary judgment motion to enforce the clause.
The key provisions of the non-compete provisions were:
(1) The non-competition period, defined as the “Restricted Period” means the period up to 12 months from the date the employee ceases to be employed by the Company as determined by the Company in its sole unfettered discretion, provided that the Company informs the Employee of the length of the period within 5 business days of the Employee ceasing to be employed by the Company.
(2) The Employee shall not, “directly or indirectly provide services, in any capacity, whether as an employee, consultant, independent contractor, owner, or otherwise, to any person or entity that provides products or services or is otherwise engaged in any business competitive with the business carried on by the Company or any of its subsidiaries or affiliates at the time of his termination (a “Competitive Business”) within North America”;
(3) The Employee shall not “be concerned with or interested in or lend money to, guarantee the debts or obligations of or permit his name to be used by any person or persons, firm, association, syndicate, company or corporation engaged in or concerned with or interested in any Competitive Business within North America,”
(4) Nothing restricts the Employee from holding less than 1% of the issued and outstanding shares of any publicly traded corporation.
(5) During the Restricted Period, the Company is to pay the Employee his or her base salary, less applicable deductions
The defendant employee successfully challenged the enforceability of the non-compete clause on several grounds. The decision illuminates the many ways in which a restrictive covenant can be successfully attacked if care is not taken when drafting it, particularly where it is provided in the context of a normal employment relationship.
Definition of Competitive Business Overly Broad in Application to Affiliates
The reference in the clause to the business of any of the company’s “subsidiaries or affiliates” meant the employee was prohibited from working in the field of providing gas cards and gift cards, which was the line of business of an affiliated company. The court held it was unreasonable to purport to prevent the employee from working in areas completely unrelated to his work for the plaintiff.
Prohibition on Working for Competitors Outside of Scope of Expertise Overly Broad
Similarly, the corporate plaintiff itself, aside from its affiliates, had lines of business unrelated to the employee’s particular work. Prohibiting him for working in all of these lines of business also went too far.
No Evidence of Harm from Holding Shares of Competitors
The clause prohibited holding 1% or more of a publically traded corporation of a competitive business. Many non-compete clauses in Canada use such boilerplate language without any apparent thought as to its enforceability. Here, the court noted there was no evidence demonstrating why this prohibition was reasonable or how ownership of 1% or more of the shares of a competitor would undermine its proprietary interests.
Length of Clause Ambiguous
The non-compete clause gave the employer the right to determine, within five days of the termination of employment, the length of the prohibition on competitive employment, up to a maximum of 12 months. This, the court found, was impermissible since, at the time the agreement was executed, its length was ambiguous.
12 Months Arbitrary
The employer invoked the non-complete clause for the maximum 12 months. Many restrictive covenants in Canada adopt a length of 12 months, without any apparent thought given to whether, if challenged, the employer could justify the length. Here, the court noted that the evidence “did not establish the duration of the software development lifecycle, or tie this to the duration of the proprietary interest” and hence 12 months was arbitrary.
Geographic Scope Overbroad
The non-compete applied to “North America”, which, the court noted, generally includes Mexico and the Caribbean. The employer’s failure to establish that restrictions on working for a competitor in those two countries were necessary also was fatal to its enforceability.
Ambiguous Reference to Employer’s Business
The definition of competitive business included any business carried on by the employer or any of its subsidiaries or affiliates at the time of the employee’s termination of employment. Given that reasonableness is measured at the time of execution, it was impossible for the employee to know, at the time he was hired, the “unlimited” number and kinds of other business his employer might carry on during his employment.
Use of the Words “In Any Capacity” Overbroad
Most colourfully, the court held that the prohibition on providing services to a competitor “in any capacity” overreached in that the employer did not establish how its legitimate proprietary interests would be threatened if the employee were to:
- Work as a janitor for the competitor;
- Provide hardware (as opposed to software) support for the competitor, either as an employee or via his own business;
- Develop his own software unrelated to the software at issue in the litigation, sell it to the competitor and provide support to the competitor in its use of it; or
- “Start a band in Mexico and be engaged as an independent contractor by (the competitor) to play at a staff retreat in Cancun.”
On this point alone, the court had no difficulty concluding that the covenant was a “blanket prohibition which unreasonably restricts (the employee’s) economic interests and goes beyond that reasonably necessary to protect (the employer’s) claimed proprietary interest”.
Source Office Furniture
The BC Supreme Court’s decision to uphold non-compete and non-solicit clauses in Source Office Furniture is an interesting contrast and reminder that, sometimes, context is everything.
In Ceridian Dayforce, the prohibition on working for a competitor “in any capacity” conjured up examples of activities which, the court held, were improperly prohibited by the non-compete clause (starting a band in Mexico and playing at a staff retreat there).
In Source Office Furniture, the defendant also attempted to invalidate the restrictive covenant by raising many hypothetical activities arising from similar wording. There, the restrictive covenants prohibited servicing or providing advice to customers “for any purpose.” The BC court found that reference to hypothetical examples outside of the office furniture and equipment business of the plaintiff would result in an “absurdity”.
The courts have available to them various tools to address allegations that restrictive covenants are defective. In Source Office Furniture the court was prepared to apply those approaches to preserve the covenants.
The court first recalled the decision of Dickson J. in Elsley v. J.G. Collins Ins. Agencies ( 2 SCR 916, 1978 CanLII 7 (SCC)), who wrote:
It is important, I think, 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. The validity, or otherwise, of a restrictive covenant can be determined only upon an overall assessment, of the clause, the agreement within which it is found, and all of the surrounding circumstances. (at pp. 923 – 924)
Importantly, in Source Office Furniture, the surrounding circumstances included the fact that the restrictive covenants were provided by a departing shareholder that sold its portion of the business to the plaintiff corporation. As a general principle, it has long been held that the courts will apply a greater degree of scrutiny to covenants attached to employment relationships as opposed to those provided in the context of the sale of a business.
The court also drew on a decision from the BC Court of Appeal which rejected the proposition that “any provision which falls short of being “definitive” in all imaginable circumstances is ambiguous”. The Court of Appeal stated in the same decision that consideration must be given to the agreement as the whole and the factual matrix, or surrounding circumstances, in which the agreement was reached. (See Rhebergen v. Creston Veterinary Clinic Ltd., 2014 BCCA 97 at paras.72 – 83).
Applying these concepts, the court in Source Office Furniture:
- Found that the words “service or provide advice” to customers was not ambiguous;
- Did not overreach in respect of the customers to which the covenants applied; and
- Held it would be an “absurdity” to construe the prohibition on providing services or advice “for any purpose” as applying to various hypothetical examples.
The temptation to focus on a particular element of a covenant, e.g. an arguably ambiguous word or a seeming overreach in the nature of activities restricted, may lead to a quick conclusion that the covenant is unenforceable. Yet if all the surrounding circumstances of the covenant are considered, a different conclusion may be reached. That is particularly the case with covenants attached to the sale of a business.