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Broader is not better |
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| Court of Appeal strikes another blow to restrictive covenants |
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Written by Malcolm MacKillop and Hendrik Nieuwland
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Monday, 24 November 2008 |
Developing and maintaining client loyalty is essential for a business
to succeed in today’s service-oriented economy. Many businesses rely
heavily on their front-line employees to build solid and lasting trade
connections with clients. But there is a hidden danger to this practice. If employees quit or are terminated,
they may try to take clients with them to a competitor or start up
their own competing business. Employers often try to prevent former
employees from recruiting their clients through the placement of
“restrictive covenants” in the employment contract.
 Restrictive covenants come in two forms. The first, called a “non-solicitation clause,” prevents former employees from actively soliciting clients away from their former employers. The second, called a non-competition clause,” prevents former employees from participating in businesses that compete with their former employers. This is a broad restriction that often prevents, for example, a former employee from doing business with a former client even if the employee does not actively solicit that client.
 If your company uses restrictive covenants to help protect its trade connections, a new decision released by the Ontario Court of Appeal, called H.L. Staebler Co. v. Allan, indicates that courts will not enforce these covenants if they are drafted too broadly.
In this case, the defendants (who were insurance salesmen) resigned from H.L. Staebler Insurance Co. Ltd. and immediately started working for Stevenson & Hunt Insurance Brokers Ltd., a direct competitor of their former employer. The defendants had developed close personal relationships with H.L. Staebler’s clients.
They asked these clients to take their business away from H.L. Staebler and follow them to Stevenson & Hunt. Some 118 clients agreed to move. H.L. Staebler then sued the defendants for damages resulting from the loss of these clients, claiming the defendants had violated the restrictive covenant in their employment contracts, which stated as follows:
In the event of termination of your employment with the Company, you undertake that you will not for a period of 2 consecutive years following said termination, conduct business with any clients or customers of H.L. Staebler Company Limited that were handled or serviced by you at the date of your termination.
H.L. Staebler was successful at trial. The trial judge found that the restrictive covenant was enforceable and that the defendants had violated the contract by soliciting H.L. Staebler’s clients to follow them to their new employer. The trial judge awarded $2 million in damages. The defendants appealed, andthe Ontario Court of Appeal set aside the trial judge’s decision, concluding that the restrictive covenant was unenforceable.
The restrictive covenant placed a blanket prohibition on the defendants from engaging in any kind of business” (even business unrelated to insurance) with H.L. Staebler clients. The covenant also had no geographical limit, and would therefore restrict the defendants from doing business with H.L. Staebler
clients anywhere in Canada. The appeal court held that the restrictive covenant was therefore a non-competition clause, the use of which is justifiable only in exceptional circumstances. The court concluded that the circumstances did not require H.L. Staebler to rely on a noncompetition clause to protect its trade connections with its clients.
The court noted that the close personal relationships between the defendants and H.L. Staebler clients were in line with the industry norm, and in any case those relationships were not exclusive, since other H.L. Staebler employees also served those same clients. The court also noted that the defendants were ordinary
salespeople and were not key employees (i.e., the defendants had “no special knowledge of or influence over the Staebler business”). Given these circumstances, the court concluded that the use of a broad non-competition clause was not justified. A “suitably restricted nonsolicitation clause” would have been sufficient to protect H.L. Staebler’s interests without unduly compromising the ability of the defendants to work in their chosen field.
If your company currently uses or plans on using a restrictive covenant in an employment contract, the Court of Appeal’s decision in H.L. Staebler Co. v. Allan indicates that the following principles should be considered:
• Carefully examine the context of the employment relationship. Whether a court will enforce restrictions placed on employeesin restrictive covenants will depend on the types of employees and their relationship to
the company. Broader restrictions may be justified for key employees who have exclusive relationships with clients, or who have special knowledge or influence over the business, but these restrictions may not be enforced for ordinary employees.
• Minimize the scope of the restriction. Courts are not likely to enforce restrictions that apply for long periods of time (e.g., greater than two years) or cover large geographic areas (e.g., all of Ontario). Assess the risk an employee may pose to your clients if that employee were to leave, and carefully craft the restrictions to provide your company with a reasonable opportunity to take proactive steps to retain those clients.
• Use a non-solicitation clause rather than a non-competition clause. Non-competition clauses are enforceable only in exceptional circumstances. In most cases, you can protect your company’s trade connections with clients by restricting former employees from soliciting those clients for a reasonable period
of time. If, however, the circumstances require the use of a non-competition clause, make sure the restriction only limits employees from engaging in business that directly competes with your company.
Malcolm MacKillop and Hendrik Nieuwland practise employment law with the firm Shields O’Donnell MacKillop LLP of Toronto. For more information, visit www. hodgsonshields.ca.
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