Restrictive covenants, such as non-competition or non-solicitation clauses, are important elements of many business acquisitions. This is primarily because a purchaser of a business is paying a premium to purchase the goodwill of the vendor, which means that the buyer will have the opportunity to continue servicing the business’ clients. Without such provisions a purchaser of a business could find him or herself on the losing end of competition from the already established vendor. This scenario would almost certainly eat into the profits of the purchaser’s venture and decrease the value of the business.
The recent Supreme Court of Canada decision of Payette v. Guay Inc. will be of interest to anyone involved in the purchase or sale of a business containing a restrictive covenant as it sets out several important legal principles. This is particularly true of the vendor who will be staying on as an employee of the buyer.
In 2004 Payette entered into an agreement with Guay Inc. to sell the assets used in his crane rental business for $26 million. To ensure a smooth transition the purchase agreement set out that Payette was to be employed by Guay for a period of 6 months after the closing date. The purchase agreement also contained non-competition provisions preventing Guay from working in the crane rental industry in the province of Quebec for a period of 5 years after the later of the closing date or from the date Payette ceased to be employed by Guay. Non-solicitation provisions were also included for the same time frame.
After the six month transitional period ended Payette was hired by Guay in a separate employment agreement. Five years later Payette was terminated without cause and he accepted a position with a direct competitor of Guay. Seven of Guay’s most senior employees followed Payette to his new employer several days later. Guay claimed that Payette was barred from taking the position due to the restrictive covenant set out in the 2004 asset purchase agreement. While Payette was successful at trial, the case was appealed to the Supreme Court of Canada (the “SCC”)
In its decision the SCC confirmed that:
“In a commercial context a non-competition covenant will be found to be reasonable and lawful provided that it is limited, as to its term and to the territory and activities to which it applies, to whatever is necessary for the protection of the legitimate interests of the party in whose favor it was granted.”
The SCC also confirmed that restrictive covenants negotiated in a sale of business context will be treated differently by courts than those in a contract of employment. This is primarily due to the fact that the inherent power imbalance in an employee/employer relationship is not presumed to exist in a vendor/purchaser relationship. This is especially true if there is evidence showing that the parties negotiated on equal terms, were advised by competent professionals, and the purchase contract does not create an imbalance between them.
The SCC set out the following factors to be taken into account when assessing reasonableness:
- Sale price (in this case $26m);
- Nature of the business’ activities (crane rental is highly mobile and specialized);
- The parties’ experience and expertise (all parties were experienced businesspeople on equal terms); and
- The parties’ access to legal counsel and other professionals (all parties were represented by lawyers and had accounting advice).
In light of those facts the SCC held that the 5 year term was appropriate. With respect to the territorial scope they held that the province of Quebec was reasonable, despite the focus of the purchased business on the Greater Montreal area. This is due to the fact that in the crane rental business the location is determined by where construction is rather then where place of business is, and the business did operate outside of Montreal from time to time.
The Court also held that non-solicitation covenants do not generally require territorial limitations. This is because the usual object of a non-solicitation clause is narrower than that of a non-competition clause, and the obligations assumed are less strict. Territorial restrictions are also not necessary because the limitation can easily be identified by looking at the list of customers. Additionally, with new technologies in the modern economy geographical limits in non-solicitations are becoming obsolete – clients may be located anywhere in the world.
Ultimately, the SCC held that Payette had to comply with the non-competition and non-solicitation provisions in the agreement.
Due to the complexity of restrictive covenants it is not advisable to enter into an agreement containing one without proper legal advice. These key elements, however, should be borne in mind whenever these types of provisions are being negotiated:
- Restrictive covenants negotiated in a commercial context as opposed to an employee / employer context will be granted greater leeway due to the lack of inherent power imbalance.
- The appropriate term, territory, and activities to which a restrictive covenant can properly apply will vary greatly depending on the specific factors in each case including the sale price, nature of the business activities, experience of the parties, and the parties’ access to professional advice.
- Non-solicitation clauses do not generally require territorial limitations.
- A buyer of a business who enters into an employment agreement with a vendor post-closing should be sure that any restrictive covenants are contained in the purchase agreement rather than the employment agreement.
- A seller of a business who enters into an employment agreement post-closing should ensure that the restrictive covenants are properly addressed to ensure that his or her obligations are clear.