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Restrictive Covenants in Employment Contracts: What Are They and When Are They Enforceable?
Employment Law

Restrictive Covenants in Employment Contracts: What Are They and When Are They Enforceable?

Employers frequently include restrictive covenants in their employment contracts. Generally, these are clauses that seek to prevent a party to the contract from taking a specific action. In the employment context, they generally take the forms of non-competition and non-solicitation clauses, which employers add to employment agreements with a view to protecting their business interests, customer bases, employee bases and/or supplier relationships. These two types of restrictive covenants serve different purposes and have different likelihoods of enforceability.

Non-Competition Clause Defined

Simply put, non-competition clauses seek to limit a former employee’s ability to work in the same market as their previous employer. They usually specify what type of conduct is restricted, the geographical area in which it is restricted, and the length of the restriction following the end of employment. Non-competition clauses seek to prevent the former employee from working in the same field regardless of whether they attempt to take the former employer’s business or resources.

Non-Solicitation Clause Defined

A non-solicitation clause seeks to prevent a former employee from soliciting the company’s clients, suppliers, and/or employees. Rather than restricting the employee from working in the same market as his or her previous employer, these clauses attempt to restrict former employees from trying to take away the former employer’s business and/or resources.

Enforceability

Although the same principles apply in determining the enforceability of both types of restrictive covenants, non-solicitation clauses are significantly more likely to be upheld than non-competition clauses. In fact, if an employment agreement contains a non-competition clause where a non-solicitation clause would be sufficient to protect the employer’s interests, the restrictive covenant will be void. (HL Staebler Company Limited v Allan, 2008 ONCA 576)

This disparity in enforceability is due to the fact that, for a restrictive covenant in an employment contract to be upheld, it must be necessary in order to uphold the employer’s proprietary interests (rather than to uphold the employer’s competitive position) and it must be reasonable as between the parties and with reference to the public interest. A total ban on competing with a former employer is less likely to be necessary or reasonable relative to a restriction on how a former employee can interact with the employer’s clients, suppliers and/or employees (HL Staebler Company Limited v Allan, 2008 ONCA 576).

A restrictive covenant is prima facie unenforceable, meaning that such a covenant is presumed to be unenforceable unless it can be demonstrated that it is reasonable. This is because a restrictive covenant is a restraint of trade, which is contrary to public policy because “the exercise of trade should be encouraged and should be free” (Shafron v KRG Insurance Brokers (Western) Inc, 2009 SCC 6).

In determining whether a non-competition or non-solicitation clause is reasonable, courts will determine whether the covenant is overly broad – that is, whether it prevents more than is reasonably required to protect the employer’s interests. First, courts will conduct an overall assessment of the covenant, the contract, and the surrounding circumstances. Second, courts will consider three factors:

  1. Whether the employer had a proprietary interest entitled to protection;
  2. Whether the time and geographical/spatial features of the covenant are too broad; and
  3. The nature of the activity that the covenant is restricting, that is, whether the covenant is unenforceable as being against competition generally (HL Staebler Company Limited v Allan, 2008 ONCA 576).

In effect, most non-competition clauses are unenforceable, whereas courts are more inclined to uphold non-solicitation clauses as they are more limited in scope.

Effect of Unenforceability

If a restrictive covenant is found to be unenforceable, the court will not amend it or correct it in order to uphold a version of it. In most scenarios, it will sever the entire covenant, completely removing any protection the employer sought to gain from the inclusion of the covenant in the contract.

Takeaways

Employers should be very careful when including restrictive covenants in their employment agreements, especially if they seek to include non-competition clauses. Such covenants must be both necessary and sufficiently limited in scope in order to be enforceable, and a finding that such a covenant is void and unenforceable will usually result in the removal of any contractual protection for the employer, regardless of whether additional protection is necessary.

Employees should seek legal advice prior to signing employment agreements and before commencing new endeavours after leaving an employment position, whether due to resignation or termination. Although many restrictive covenants in employment agreements are unenforceable, it is possible for employers to draft valid clauses that restrict an employee’s post-employment conduct.

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