Non-competes

There are two main kinds of non-competition agreements. The first is a written agreement between a vendor of a business and a purchaser. Under this kind of agreement, the vendor agrees not to compete with the purchaser after the sale. Obviously, there would be little point for a purchaser to acquire a business if its founder could launch a competing business or bring all of his or her skill, expertise and personal goodwill–whether as an innovator, a manager or a leader–to a competitor. As a result, courts tend to view this kind of non-competition agreement as a bought-and-sold right of the purchaser, and they often will enforce it.

The second kind of non-competition agreement is a written provision between an employer and an employee that becomes part of the legal employment relationship. In comparison to non-competition agreements that are part of a business transaction, non-competition agreements in the employment context are less enthusiastically enforced by the courts. The reason is that, in the courts’ view, the possible negative impact on an employee of not being able to do work that he or she is qualified to do generally outweighs the employer’s interests.

This is not to say that the interests employers might seek to protect are not substantial. But it is to say that an employee’s ability to earn a living is generally a more compelling consideration. There are various reasons for this. One reason is that although courts view some interests of employers as legitimate (e.g., safeguarding confidential information, or trade secrets, and protecting employees and customers from being solicited by former employees), these interests can often be protected adequately by non-solicitation and confidentiality (or non-disclosure) agreements. In a good percentage of cases, a non-competition clause would add little protection to what is already offered by these agreements. A second reason, which is connected to the first, is that while an employee subject to a non-solicitation agreement can still work for another employer, the same employee subject to a non-competition agreement may not have any way to earn a living doing what he or she knows how to do. Simply put, a restraint of trade is something our courts discourage. Finally, there is generally an inequality of bargaining power between employees and employers, which usually leads our courts to choose the path which tries to rectify that imbalance.

There may be some good reasons to use a non-competition clause, however. Where an employer cannot be protected adequately through the combination of a non-solicitation and a confidentiality agreement or where an employer’s business interests (or vulnerability to competition by former employees) are substantial enough to justify the restriction placed on the employee’s ability to earn a living, non-competition agreements may be a form of protection worth seeking.

All of this said, courts will sometimes take the view that non-competition agreements between a startup and its senior employees (e.g., founders and senior executives) are enforceable, while agreements with employees in lesser positions of responsibility and control are not enforceable. Not only are founders and executives more intimately knowledgeable about a startup’s business, its internal operations, and its challenges and opportunities, but they also might simply be viewed as having accepted a position which is incompatible with competing with the business. However, note that even in some of these cases, non-competition agreements are struck down by the courts, and while it still may be possible to make the claim that the executive or founder has breached fiduciary duties not to compete, that approach requires litigation, which may not be the preferred option.

A well-drafted non-competition agreement, therefore, must be aimed at achieving a reasonable balance between protecting your startup when an employee joins a competitor or launches his or her own startup, and permitting the employee the ability to earn a living by doing work which he or she is qualified to do. If a non-competition agreement is going to be used, it should be carefully considered and drafted, failing which it and any other covenants can be struck down, with the result that there will no longer be any protection for the employer. This balance can be tricky, and even a relatively short-term or modest restriction can run afoul of a court’s sensibilities.

In the Ontario Court of Appeal decision in Mason v. Chem-Trend Limited Partnership (Chem-Trend) offers a summary of the law in Ontario relating to the enforceability of non-competition agreements. In general terms, a non-competition agreement will be enforceable if it is reasonable. This means that not only must the scope of the activity that the employee is prohibited from undertaking be reasonable, but the time for which the employee is prohibited from doing that work and the geographic place in which he or she is prohibited from doing it must also be reasonable. In addition, the agreement cannot effectively serve as a restraint of trade. Note, however, that in some cases any restriction at all will be unreasonable and no standard set of terms can be used with any assurance that a court will approve of it.

There are four aspects of unreasonableness that should be paid attention to when drafting non-competition agreements. The first is the burden that the agreement places on the employee. Is the restriction of the employee’s ability to earn a living unduly burdensome or inappropriate? The second is whether the agreement–even if it is not unduly burdensome–is practical. Is it even possible for the employee to comply with the terms of the agreement? The third is whether the particular terms (i.e., scope, geographic jurisdiction and duration) are overly broad. And the fourth is whether the restriction is ambiguous.

It is important to make sure that any agreement you sign with an employee makes sense in light of the particular circumstances of the employee, his or her particular position with your company, the vulnerability your company would suffer if he or she joined a competitor, and the likely effect that the non-competition agreement would have on him or her. For example, a court might refuse to enforce even a six-month restriction on an employee’s ability to work on the basis that the interruption in employment in some industries is too long and would effectively prohibit the person from finding work in that industry again.

A court similarly will not enforce an agreement which provides greater protection than is required to adequately protect the employer. In Chem-Trend, the restrictions imposed by the agreement were internally-inconsistent since prohibiting an employee from soliciting and even dealing with all former customers was – in the case of a 17-year employee – simply incompatible with the one-year restriction on competition that the agreement imposed. Certainly, if an employee’s information about a company and its clients is no longer current or useful after a year, then prohibiting the same employee from dealing with any person who was ever a client of the company is unnecessary to the point of being unreasonable. The court in Chem-Trend therefore rejected the agreement outright; it did not simply pare back its terms to what, in the court’s view, would have been reasonable. On this point, it is important to note that Canadian courts will generally strike down altogether a problematic non-competition agreement rather than redraft or cut out the problematic parts of it.

Further, a court will not enforce a non-competition agreement which is practically impossible for an employee to comply with. For example, even if the restriction in Chem-Trend had been otherwise reasonable, it could not have been complied with. After leaving Chem-Trend, the employee would not have had any way of knowing or determining whether a prospective customer had been at any point a customer of Chem-Trend.

Finally, terms which are ambiguous (at least in part) will be considered by the court to be unreasonable and entirely unenforceable. For example, in the case of Shafron v. KRG Insurance Brokers, the term Metropolitan City of Vancouver was considered ambiguous because there is no city that is legally defined as such. Although it is a fairly easily understood idea, the term was not defined with sufficient specificity for the court to say in any particular case whether any location was within or outside the geographic area described in the agreement.

Questions? Email us at startups@dentons.com.