Non-Competition Clauses: Are They Enforceable?

The short answer: maybe.  

Whether a non-competition clause in a contract is enforceable rests not only on the actual language of the clause, but also on the context of the relationship.  Non-competition clauses, which exist in the context of an employment relationship, have very limited enforceability, while non-competition clauses in the context of a sale of a business are given great latitude.  Somewhere in between rests the non-competition restrictions found in franchise relationships.

This article focuses on the enforceability of non-competition clauses in commercial agreements – primarily, those agreements concerning the sale of a business.  A recent Supreme Court of Canada decision, Payette v. Guay Inc. (2013 SCC 45), confirmed that great latitude will be given:

• To parties who are on a perceived even playing field;
• Have all received legal advice as part of the transaction;
• Where significant consideration has been exchanged, in return for the agreement to not compete.

The Commercial Non-Compete: Context

The Court notes that in employment relationships, there is usually an imbalance of power between the employee and employer; however, the Court finds no such imbalance in the commercial transaction context.

The Supreme Court emphasized that the context of the non-compete is critical to determining the enforceability of it.  In Payette, the vendors of a business not only sold their business, but also, as is common, agreed to stay on and work for the new owners of the business for a period of time.  The vendors agreed, in the agreement for the sale of the business, to a five-year non-competition clause, which started to run on the day on that the vendors ceased to be employees of the purchaser.  Despite the fact that the non-competition clause was tied to the employment term of the vendor, the Court found that the agreement to not compete was tied to the purchase terms, not the employment terms.  The Court found that the vendors had negotiated the clause not as employees, but as vendors.  The Court also noted that the employment contracts themselves did not contain non-compete obligations, providing further proof that the non-compete was not tied to the employment relationship.

The Court also found that the significant compensation in the sale transaction, in this case $26 million, was partially paid to obtain the “goodwill” of the company.  The Court specifically noted the language in the purchase document, which dealt with the non-competition agreement: “in consideration of the sale which is the subject of the offer …”.  This language made it clear that the purchase price was, in part, for the non-compete terms.

Reasonableness Test

The Court confirmed that the test of enforceability for a non-competition clause in a commercial agreement is whether, given the context of the agreement, the restrictions were reasonable.  The Court confirmed that, in a commercial context, the burden of proving that the restrictions are not reasonable lay with the party bound by the restriction - in this case the vendor.

The test of reasonableness is whether the restrictions, “in both term and territory, are limited to whatever is necessary for the protection of the legitimate interests of the party in whose favour it is granted.”  The factors that the Court will take into account to determine reasonableness are listed as “the sale price, the nature of the business activities, the parties’ experience and expertise and whether the parties had access to the services of legal counsel and other professionals.”

Regarding the limitation of time, the Court confirms that there must be some limit on time or the clause will be found to be contrary to public policy and therefore void.  However, the Court also notes that clauses for as long as ten years have been found to be reasonable.  Limits on territory should be to that area in which the business being sold carries on its trade or activities as of the date of the transaction: a clause which applies outside the territory in which the business operates is contrary to public order.

Non-Solicitation Clauses

The Court also notes that a non-solicit clause is given greater latitude and does not need to be limited by geography, as the “new economy” does not limit customers and clients to being within a geographic area in relation to the business.

How to Write Enforceable Non-Compete Clauses

In summary, while non-competition clauses in a commercial context will be given far greater latitude than in the employment context, such clauses do need to be carefully worded, particularly in a situation where a vendor is staying on to work with the new business owner.  A few key points to address:

• Ensure that the non-competition clause is clearly identified as tied to the compensation being delivered as part of the sale transaction;
• Ensure that the non-competition clause appears in the business transaction documents, not a subsequent employment agreement;
• Limit the non-competition clause to only that duration and territory, which is reasonably necessary to protect the interests being purchased;
• Ensure that “goodwill” is identified as one of the assets being purchased and specifically identify the value of that goodwill, where appropriate; and
• Include non-solicitation restrictions, in addition to the non-competition restrictions.

How Momentum Can Help

Whether you are entering into a new commercial or employment relationship, we can help you draft agreements with carefully crafted (and enforceable) non-competition and non-solicit provisions. We want to ensure that your intentions when entering a business or employment relationship are honoured if and when that relationship ends.