What's "reasonable" on a restrictive covenant?

What's a "restrictive covenant"?

In contract law, a "restrictive covenant" is a part of a contract which limits one party's freedom of action. ("Covenant" is just a fancy word for "bargain" or "agreement", and restrictive speaks for itself.) Common examples of restrictive convenants are non-competition or "no moonlighting" clauses in employment contracts and restrictions on land use in real property sales.

The Staebler case: Restrictive employment Covenants in Ontario

The Ontario Court of Appeal, (Ontario's highest appellate court, subject to being overridden only by the Supreme Court of Canada) in H.L. Staebler Company v. Allan et al.* recently examined whether a restrictive covenant in an employment contract was reasonable

The defendant employees were commercial insurance sales people who left their , left their employer for a competing insurance broker, also named as a defendant. The employees had, with their previous employer (the plaintiff) contracts with a restrictive covenant which mandated that they wouldn't conduct business with any of the plaintiff's clients they to whom they had provided service for two years after termination: a non-competition clause. Over a hundred clients moved their business to the defendants' new employer. The plaintiff sought and obtained an injunction, (which is "an order of the court requiring a person to not do some act or not continue to do some act that the court considers they have no right to do or, in the case of a mandatory injunction, an order that requires the person to do what the court considers they are legally required to do").

The case went to trial where the trial judge found that the restrictive covenant was enforceable, that the defendants had to pay general damages (also called compensatory damages) but not punitive damages. Both sides appealed that decision.

The Court of Appeal allowed the appeal by the defendants, (finding the restrictive covenant unenforceable), and dismissed the employer's cross-appeal which sought punitive damages. Why?

• The restrictive covenant did not meet the test for enforceability set out by the S.C.C.: “only if it is reasonable between the parties and with reference to the public interest”.

" ... This test reflects the competing principles that must be balanced when a court is called on to decide the validity of such a covenant. On the one hand, there is the `important public interest in discouraging restraints on trade, and maintaining free and open competition unencumbered by the fetters of restrictive covenants'. [...] Open competition benefits both society and the affected employees. Society benefits from having greater choice and employees benefit as they have greater employment opportunities. On the other hand, however, `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'. [...]"

• "Neither of trial judge's findings that employees knew they would not receive benefit of `gifted' clients unless they signed employment contracts with employer or that employees enjoyed close personal relationship with clients justified trial judge's conclusion that restrictive covenant was reasonable."
• The absence of geographical limit combined with blanket prohibition on conducting business rendered restrictive covenant overbroad and unenforceable.
• The clause unreasonably restricted employees' economic interests and went beyond what was necessary to protect employer's proprietary interest; a "non-solicitation clause" was enough in in conventional employer / employee situations
  

It is also of note that the Court of Appeal, in deciding that the restrictive covenant was not enforceable thus concluded that the new employer (also a named defendant) was not liable for the tort of inducement breach of contract. (Note: that tort will be covered in a subsequent post. Keep an eye out for it by signing up for the RSS feed at lower right.)

Footnote(s)
* "et al." is the abbreviation for the Latin phrase meaning "and the others". It is used in case citation where the "title of proceedings" (also called the "style of cause", which is the proper case name found on the court documents) has multiple parties. Nobody wants to have to write down a many, many names just to name the case, so the first surname or company name found in the title of proceedings is used, followed by "et al." to let you know of all the others. In this case there were seven defendants, the first-named of whom in the title of proceeding was Tim James Allan, hence "...Allan et al.".

Further Reading:
Elsley v. J.G. Collins Insurance Agencies, [1978] 2 S.C.R. 916, 1978 CANLII 7, (S.C.C.): the Supreme Court of Canada's take on restrictive covenants and restraint of trade.