Are courts more willing to enforce restrictive covenants?

Prima facie all covenants in restraint of trade are illegal and therefore unenforceable[1]. Recently, this pillar of the law of contract has been given a new, albeit off-putting, coat of paint. The "covenants in restraint of trade" referred to above most commonly take the form of non-competition or non-solicitation agreements that prevent employees from competing with their employers and/or soliciting customers of their former employers for a period of time after leaving their employment. Restrictive covenants are also common in circumstances where the vendor of a business agrees to restrictions on the ability to compete with the purchaser of that business for a period of time thereafter.

Courts have traditionally held that the restrictive covenants are presumed to be illegal as contrary to the public policy against restraining trade unless and until the employer seeking to enforce the covenant can satisfy the court that the covenant goes no further than is necessary to protect its proprietary interest in its actual customers and business relationships. Recent case law makes it appear that it may be easier to satisfy that onus and enforce a restrictive covenant.

In the recent Alberta case of Unified Freight Services Ltd. v. Therriault[2], the plaintiff/employer, Unified Freight Services (UFS), successfully obtained judgment against its former sales supervisor for, among other things, breach of a restrictive covenant contained in a confidentiality agreement.

The employer, UFS, is a freight-forwarder in the logistics business. Competition for customers is fierce and, as a result, UFS developed policies restricting staff use of company information and access to customers. All UFS employees were expected to review and consent to the terms of a Company Policy Manual including a Confidentiality Agreement requiring that employees shall not be in contact with any customer of the company after employment for a period of one year for the purposes of freight forwarding. After consulting with a lawyer, Therriault agreed to the Confidentiality Agreement.

At trial, Alberta Queen’s Bench Justice Erb found the covenant to be reasonable and enforced it against Therriault, stating, "The only effective restriction to protect [UFS’s] proprietary interest in its customers cultivated by its sales personnel, including Mr. Therriault, was a prohibition on all contact for a reasonable period of time." Erb J. relied on the Supreme Court of Canada’s decision in J.G. Collins Insurance Agencies Ltd. v. Elsley[3] to the effect that, although there can be no proprietary interest in people or enterprises that were not actual or potential customers, in some cases the nature of the business and the particular employment might justify a restriction beyond the mere solicitation of business.

Here, Erb J. found that a sales supervisor in the "fiercely competitive" freight forwarding business could properly be prevented from making any contact with any customers of UFS. This is more onerous than a covenant that prevents only the actual solicitation of a former employer’s customers.

Regrettably, the decision of Erb J. does not elaborate on why this is such an exceptional case and why the prohibition on all contact with former customers is the "only effective restriction." Instead it simply states that the decision was "based on the evidence tendered at trial." And so it remains to be seen what authoritative weight this decision will carry.

Therriault comes on the heels of another rather curious decision, Martinrea International Inc. v. Canadian Hydrogen Energy Co.[4], in which Justice Ducharme of Ontario’s Superior Court, found a somewhat vague non-competition covenant to be globally enforceable for a term of five years. In this case, although Martinrea initially agreed to a non-disclosure agreement containing the non-competition agreement, it later sought to have the non-competition clause declared unenforceable.

Despite the fact that the defendant, Canadian Hydrogen Energy Co., did not operate on a worldwide basis, and although the clause in question did not refer to a specific time frame, Ducharme J. found that, Canadian Hydrogen’s "aspirations to expand into international markets at an appropriate time" were enough to justify a covenant that prevented it from competing on a global scale.

Ducharme J. interpreted the non-competition covenant to be enforceable for five years even though Canadian Hydrogen Energy Co. had only been in existence for two years and the technology at issue could possibly undergo two or more generational changes within one five-year period. Ducharme J. found that the time period contained in the non-disclosure agreement was similarly applicable to the non-competition clause.

Although Ducharme J. acknowledged the important public interest in discouraging restraints on trade and maintaining free and open competition unencumbered by the fetters of restrictive covenants, he stated that the courts "have been disinclined to restrict the right to contract, particularly when that right has been exercised by knowledgeable persons of equal bargaining power."

The decision and reasoning in Martinrea was upheld by the Ontario Court of Appeal on October 12, 2005[5], with the majority of the appeal panel finding that "[Canadian Hydrogen] executed the agreement fully cognisant of the terms of the restrictive covenant" and, as such, the covenant should be enforced. In a strongly worded dissent, however, Madam Justice Cronk outlined her serious concerns that the 5-year term of the covenant was not appropriate, given that it exceeded the time necessary to protect the product of the respondent that existed when the contract between the two parties was entered into.

Both of the above decisions seem to fly in the face of the law concerning restrictive covenants. Generally, regardless of parties’ relative bargaining power, a restrictive covenant is not enforceable unless its subject-matter, duration and geographical ambit are no wider than is necessary to protect the propriety interest at stake.

However, if the decisions in Therriault and Martinrea are any indication, then there may be much more flexibility in that test than previously thought and the courts may be more willing to enforce restrictive covenants – especially where they are negotiated and agreed upon by parties with full knowledge of their terms and a relative equality of bargaining power.

As always, time will tell, but in the interim, parties entering into such covenants, in either the employment context or other commercial contexts, should be very wary about any advice that attempts to minimize the significance of a restrictive covenant on the basis that courts rarely enforce them.

Published September, 2006