Restrictive covenants can be tricky. Most of the difficult issues in employment law have been ironed out by the courts. That is the inevitable effect of hundreds of decisions by judges every year touching on all aspects of the employment relationship.
One area that still seems to lack a sufficient degree of certainty is the enforceability of restrictions on post-employment competition. This uncertainty is highlighted when lower court decisions on this topic are frequently overturned on appeal.
Restrictive covenants aim to limit post-employment activities
Various forms of restrictive covenants are used by employers to govern the post-employment activities of key employees. The employer seeks to protect itself from damage imposed by former employees engaging in competitive business activities.
Non-competition covenants limit the former employee’s ability to compete in the same industry. Non-solicitation covenants are intended to prevent the former employee from approaching the employer’s customers. Another form of non-solicitation covenant prevents the former employee from hiring away the employer’s other employees.
Covenants may protect against competition
It is a matter of public policy that individuals should have the ability to carry on their chosen trade. Judges are highly reluctant to uphold these limitations on the activities of a former employee. But, within certain narrow boundaries, restrictive covenants can be successfully used to protect a business from the competitive threat posed by former employees.
Covenants may be ruled unreasonable
The problem is that employers (and their lawyers) have little certainty that such a covenant will be deemed reasonable if it is ever scrutinized in court. An example arose recently when the Ontario Court of Appeal overturned a $2 million award of damages against two individuals who acted contrary to the terms of such restrictions.
Allen and Kienapple signed broad restrictive covenants as part of their employment with insurance broker HL Staebler Co. Ltd. The covenants were for a two-year period following the cessation of the relationship. They prohibited Allen and Kienapple from conducting business with any client which they had serviced during their employment with Staebler.
They resigned from their employment in 2003 and immediately went to work for a competitor. In a very short time span, over 100 of Staebler’s clients had moved their business to Allen and Kienapple’s new employer.
At trial, the judge enforced the covenants and awarded damages in accordance with their terms (which included a formula for calculating the resulting damages).
The appeal judge, however, disagreed with the trial judge both in relation to the characterization of the covenants and as to whether they were reasonable. The appeal judge found that the covenants went well beyond protecting Staebler’s trade connections with its clients.
This is the sort of see-saw result that employers detest (and employment lawyers fear). It demonstrates just how challenging it is to craft a restrictive covenant which will meet the satisfaction of the courts.
It can be compared with a recent BC case involving a company called KRG Insurance Brokers (Western) Inc. and an employee named Shafron. In that case, the trial judge determined that the covenant restricting Shafron’s post-employment activities was overbroad and unenforceable.
BC’s Court of Appeal not only reversed that decision, but took the stated geographical scope of the restrictive covenant (being “Metropolitan City of Vancouver”) and expanded it to include the municipalities surrounding the city.
Employers might be well justified in asking how one court or judge can find a covenant to be reasonable (and proceed to award millions of dollars in damages) and another judge can come to the complete opposite conclusion. Their concern about the unpredictability of court decisions in this area seems to be well founded. This makes restrictive covenants a risky form of insurance against later competition by employees.
Ultimately, this provides good reason for employers to adopt a “less is more” approach in drafting restrictive covenants. Simply put, the lesser the restriction on the employee’s activities, the more likely it is to be viewed – by all judges – as reasonable.
Robert Smithson is a partner at Pushor Mitchell LLP in Kelowna practicing exclusively in the area of labour and employment law. For more information about his practice, log onto www.pushormitchell.com. If you have a labour or employment question for him to answer in a future “Legal Ease”, email him at firstname.lastname@example.org. This subject matter is provided for general informational purposes only and is not intended to be relied upon as legal advice.