The Re-Emergence of Blue-Pencil Severance of (some) Restrictive Covenants
The Alberta Court of Appeal holds that blue-pencil severance may be used to alter restrictive covenants that restrain employee competition, provided the covenant was part of the sale of a business.
The practice of “blue-pencil” severance in employment restrictive covenants was thought to be all but dead after the Supreme Court of Canada’s 2009 decision in Shafron v. KRG Insurance Brokers (Western) Inc.
Historically, blue-pencil severance had been used to strike out, or literally run a pencil through, a portion of a restrictive covenant that was found to overreach, in order to render it reasonable. In Shafron, however, the Court held that blue-pencil severance should be resorted to only sparingly, where the part being removed was “trivial.” The Court noted that application of severance to an overly-wide covenant would invite employers to draft broadly, relying on the courts to sever unreasonable parts.
As noted in The Canadian Employee Competition Blog, some courts subsequently questioned the applicability of Shafron to covenants given as part of the sale of a business. In City Wide Towing, the Alberta Court of Appeal has rendered the first appellate decision limiting Shafron’s applicability.
As part of an asset purchase agreement for the sale of his towing business, the vendor agreed not to compete in Alberta, BC and Saskatchewan and any other location within Canada where City Wide carried on business during the five years from the date of sale. Partway through the five years, he resigned and soon thereafter started working for another towing company in Alberta.
The purchaser succeeded in obtaining an interlocutory injunction in chambers to prevent the vendor from working for the competitor. The vendor appealed on the ground that the business operated by his new employer was not competitive. This ground failed, with the Court finding the businesses were sufficiently similar.
The vendor’s second ground of appeal was that the covenant’s geographic reach was too wide. At the time of the purchase, City Wide Towing did business in Alberta, but not in BC and Saskatchewan.
The Court of Appeal agreed the covenant extended too far. While City Wide, at the time of sale, planned to do business in BC and Saskatchewan, reasonableness is determined by reference to where the enterprise being sold actually performs business at the time of sale. On this basis, the covenant was unreasonably broad.
This was not the end of the matter, however. Despite neither party raising the prospect in chambers or in their appeal factums, the Court invited submissions on whether it could, and if so should, apply the doctrine of blue-pencil severance to render the covenant reasonable.
Having received the parties’ submissions, the Court framed the central question in the appeal as “whether a restrictive covenant that is entered into as part of the sale of a business, and which is prima facie unenforceable as overbroad in geographical scope, may be saved by application of severance principles.” (at para. 42)
The Court distinguished Shafron on the basis that the covenant at issue there was given in the context of an employment agreement. Here, the covenant was given pursuant to a separate agreement arising from the sale of the business. (There were separate, shorter covenants, contained within the employment agreement between vendor and purchaser).
The Court noted the sound policy reasons for limiting the application of blue-pencil severance to covenants in employment agreements: “the imbalance in the relationship between employer and employee, with public policy favoring the employee’s right to freely carry on her occupation over that of the employer to restrict it unreasonably.” (at para. 46)
The absence of a presumed imbalance in vendor-purchaser transactions opened the door for the Court to apply blue-pencil severance in the case before it. The Court concluded that Shafron does not speak to blue-pencil severance of covenants in commercial contracts, including employment covenants given as part of a sale of a business.
The Court then proceeded to sever the definition of “Non-Compete Area” as follows to save the restrictive covenant:
“Non-Compete Area” means the Provinces of Alberta
, British Columbia and Saskatchewan and any other location within Canada where the Corporation and its Affiliates are carrying on the Business at any time during the Restriction Period.
Interestingly, the Court also took note of recent English authorities holding that severance may be applied in both employment and commercial contracts cases. These authorities include the UK Supreme Court’s decision in Tillman v. Egon Zehnder Ltd.,  UKSC 32, which departs from the Canadian approach in Shafron regarding restrictive covenants given in employment agreements.
Ultimately, the Court in City Wide Towing was able to distinguish Shafron, convincingly it is submitted, as applying only to covenants given as part of employment contracts. The vendor has appealed the decision to the Supreme Court of Canada. If upheld, the decision will be a welcome relief to purchasers of businesses who seek to protect their investments through the use of restrictive covenants.