High court rules on noncompete, nonsolicitation clauses in business sale

November 03, 2013 - by: Isabelle East-Richard 0 COMMENTS

By Isabelle East-Richard

A recent Supreme Court of Canada decision arising out of Québec will have broad ramifications across Canada.

In Payette v. Guay Inc. (2013 SCC 45 (September 12, 2013)), the Supreme Court of Canada settled the debate over whether the employment contract provisions of the Civil Code of Québec also apply to noncompete and nonsolicitation clauses set forth in business sale agreements. In so doing, it addressed the distinction between the rules that apply to restrictive covenants found in an employment contract and those found in a contract for the sale of a business.

Facts

In October 2004, Guay Inc., a crane rental business, purchased the assets of Groupe Fortier, a competitor owned by Yannick Payette and his partner. It paid them $26 million.

Payette and his partner agreed, among other things, to be bound by noncompete and nonsolicitation clauses for a period expiring five years after they were no longer employed by Guay Inc.

To ensure the smooth transition of the operations of Groupe Fortier, the parties agreed that Payette and his partner would work for Guay Inc. for at least six months. It turned out that Payette remained in the employ of Guay Inc. until August 2009. He was then dismissed without “serious reason” (a concept similar to “just cause” under Canadian common law). Payette was later hired by one of Guay’s competitors. Soon after, seven employees left Guay to join him.

Guay Inc. applied for an injunction. It sought an order requiring Payette to comply with the noncompete and nonsolicitation clauses to which he had agreed.

Lower court decisions

The Superior Court of Québec found that the restrictive covenants were part of Payette’s employment contract that had been integrated into the sale agreement. The employment contract provisions of the Civil Code of Québec therefore applied. The covenants weren’t enforceable because Payette was dismissed without serious reason. The injunction was denied.

The Court of Appeal of Québec, however, considered that those restrictive covenants had been agreed upon between the parties in order to protect Guay Inc.’s investment and not because of Payette’s employment. Analyzing the restrictive covenants based on the criteria that apply to commercial transactions, the Court of Appeal ruled that they were enforceable. It therefore quashed the Superior Court’s decision and issued the permanent injunction that had been requested.

Supreme Court of Canada decision

The Supreme Court of Canada began its analysis by clarifying that there is an important distinction between the rules that apply to restrictive covenants found in an employment contract and those found in a contract for the sale of a business. The principles applicable to the interpretation of restrictive employment covenants don’t apply with “the same rigour or intensity” in the context of a commercial contract as compared with an employment contract.

A vendor and a purchaser are presumed to have equal bargaining power, contrary to the norm with employers and employees. Unlike the employment context, therefore, restrictive covenants are presumptively valid in the commercial context. The onus is on the vendor to show that they are not reasonable.

The court analyzed the wording of the covenants and the circumstances under which they had been agreed upon. This analysis allowed the court to find that the purpose of the covenants was to protect the assets acquired by Guay Inc. Payette had agreed to them because of the sale of his business and not because of his services as a consultant. As a result, the Civil Code of Québec’s employment provisions couldn’t apply in this case.

The court went on to analyze the restrictive covenants by applying the reasonability criteria applicable to commercial transactions. The court found that the term, territory, and activities provided for in the noncompete clause were reasonable under the circumstances.

As for the nonsolicitation clause, the court ruled that it was also reasonable even though it didn’t contain a territorial limit. Its scope could easily be determined by analyzing the targeted clientele.

Since Payette was unable to prove that the restrictive covenants were unreasonable, the Supreme Court dismissed his appeal.

Lessons for purchasers/employers

It’s now clear that the protection offered by a noncompete or a nonsolicitation clause in a contract for the sale of a business is superior to the protection granted by such clauses in an employment contract.

If a vendor or one of its principals becomes the purchaser’s employee, the new employer would be wise to include such clauses in the agreement of purchase and sale. Such clauses can remain in force during employment and for a reasonable period of time thereafter.

Still, such clauses must be drafted with great care in order to ensure that they meet the reasonability criteria that apply in a commercial context, given the significant consequences likely to result if they are found to be unenforceable.

About Isabelle East-Richard:
Isabelle East-Richard specializes in labour, employment, and human rights law, with a particular focus on issues of certification, class actions, labour standards, and employment agreements. She also works in conflict resolution, particularly in the context of commercial litigation and civil and extra-contractual liability.

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