Non-Competition and Non-Solicitation: Protecting Your Business from Departing Employees
This article originally appeared in Lēad Magazine, Issue 17 – Competition: a driving force.
By Jennifer Heath, B.SC., LL.B. Associate at Rubin Thomlinson LLP
Contingency planning is an essential aspect of long-term business growth. An often overlooked part of contingency planning is the impact of employee departures on a business’ long-term success. Specifically, employers should consider the following: would there be any harm to the business if a key employee resigns and then sets up a competing business or solicits major customers? If the answer is yes, then the employer must determine whether it can restrict the employee from engaging in competitive post-termination activity and, if so, how to restrict such activity.
There are a number of factors an employer must address when enacting post-termination restrictions (aka restrictive covenants), which affect the utility and enforceability of those restrictions. Below, we have summarized the following:
- What are restrictive covenants?
- Identifying the most common types of restrictive covenants
- Judicial scrutiny of restrictive covenants
- Increasing the likelihood of enforceability
What are restrictive covenants?
Undeniably, an employee owes a duty of loyalty to his or her employer during employment. Restrictive covenants impose limitations on an employee’s activities after employment ends. Unlike the duty of loyalty, restrictive covenants generally require an explicit agreement between the employer and the employee.
Identifying the most common types of restrictive covenants
The most common types of restrictive covenants are as follows:
A non-competition restriction prohibits an employee from competing with his or her former employer for a specific time period following his or her departure. “Competing” may take a number of forms, including setting up a new venture in the same industry or joining a competitor’s business.
A non-solicitation restriction constrains an employee’s ability to solicit customers, employees, suppliers, etc. of his or her former employer. For example, an employee may solicit a customer by contacting him to offer services similar to those of the former employer. An employee may solicit a former co-worker by persuading him or her to resign. Although less common, an employee may solicit a supplier to stop supplying a limited resource to the former employer.
Alternative types of restrictive covenants include non-acceptance (i.e. not accepting business from former clients, even if such business was not solicited) and non-disparagement (i.e. not making derogatory comments about the employer or its employees).
Judicial scrutiny of restrictive covenants
Courts are hesitant to enforce non-competition and non-solicitation restrictions. Fundamentally, these restrictions represent a restraint of trade, which is contrary to public policy. However, where an employer can show that the restriction is reasonable and certain and does not go further than is necessary to protect the employer’s proprietary interests, a court may find such restrictions to be enforceable.
In addition, a non-competition restriction must be reasonably narrow with respect to the:
- geographic area;
- duration; and
- type of activity restricted.
For example, a clause that prevented a former salesperson who sold widgets in Ontario from selling widgets, doohickeys and thingamajigs anywhere in North America for five years would likely be unenforceable. In contrast, a more tailored restriction, such as one preventing a key widget salesperson from selling widgets in the City of Toronto for six months post-termination, is more reasonable and thus more likely to be upheld by a court.
Increasing the likelihood of enforceability
If restrictive covenants are so prone to being struck down by judges, then how can employers ensure that they are enforceable? There is no such thing as an ironclad restrictive covenant, but there are some important steps to take to improve the chance that a clause will pass judicial scrutiny:
- Get it in writing
It is rare that courts will impute non-competition or non-solicitation obligations on an employee unless they are set out in a written agreement. Since you cannot count on goodwill alone when an employee departs, put the agreement in writing.
- Get consideration
While reducing the restrictive covenants to writing is a first step towards enforceability, something more is required. There must be consideration – i.e. the employer must give the employee something of value in exchange for the agreement to be bound by the restrictions. Continued employment is not consideration. Ideally, the initial offer of employment will set out the restrictions and thus the consideration is the employment itself. However, a bonus or other extraordinary compensation during employment can also be consideration. Without consideration, even a written agreement is not enforceable.
- Use narrow restrictions
A non-competition clause is more restrictive than a non-solicitation clause: the former restricts an employee from working in the industry at all, while the latter permits an employee to work in the industry, but makes certain clients or employees off-limits. Where a non-solicitation clause is sufficient to protect the employer’s business interests, then it should be used instead of a non-competition clause. A court will strike out a non-competition clause where it deems that it is “overkill” in protecting the employer or where the length or geographic scope or types of activity are overly restrictive. Employers should use the most minimal restrictions necessary to protect their interests.
- Courts don’t draft restrictions
Often, employers assume that if the restriction is too oppressive, the court will simply re-write it or “read it down”. In the employment context, there are few, if any, instances in which a court will amend restrictive language: it will either uphold the language or it will deem it to be void and unenforceable.
- Different approach in the sale of a business
Notwithstanding the courts’ general reluctance to enforce restrictive covenants, they are more open to upholding such restrictions as part of the sale of a business. Where a purchaser is buying an asset with a value contingent upon the seller’s agreement not to compete, the agreement is more likely to be upheld.
As part of any good contingency planning, employers must look at the risk that employees could pose to the business post employment. If post-termination solicitation or competition by departing employees poses a real threat to the business, then the employer should ensure that employees enter into valid and enforceable non-solicitation and non-competition agreements to minimize the threat.