Non-compete covenants and the sale of a business

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When a Purchaser acquires a business from a Vendor one of the most important covenants to the Purchaser is the non-competition covenant given by the Vendor.  Sometimes the non-compete covenant is contained in the acquisition agreement, sometimes it is contained in a post-closing employment contract and sometimes it is contained in both locations.  The Supreme Court of Canada has recently provided useful guidance to help ensure that the non-compete covenants provided by a Vendor are enforceable by a Purchaser.

Courts have traditionally drawn a distinction between non-competition clauses negotiated in a sale of business or transactional context and those in the employment context, with the former being afforded more generous or liberal rules. The imbalance of power that characterizes the employer-employee relationship provides a justification for stricter rules being applied in the interpretation of such clauses, with the purpose of protecting the employee. Such an imbalance of power is not presumed in a Vendor-Purchaser relationship, where negotiating parties are often on equal footing and have the benefit of legal and financial advice. The purpose of negotiating a non-competition clause in this context is generally to enable the Purchaser to protect their newly acquired investment.

The line between the transactional context and the employment context is blurred where a non-competition clause is inserted into a sale of business agreement in circumstances where the Vendor also becomes the Purchaser’s employee. Determining which rules apply to the interpretation of the clause in this scenario requires identifying which contract or master agreement the principal obligation is linked.  

This contextual overlap was considered recently in Payette v Guay inc., 2013 SCC 45. In October 2004, Guay inc. purchased the assets of a crane rental business from a competitor, Groupe Fortier, who was controlled by Yannick Payette and his partner. To provide for a smooth transition, the sale agreement provided that Payette and his partner would work full time as consultants for the Purchaser for 6 months, with the option to negotiate a new employment contract beyond the transition period. The sale agreement further provided that in consideration of the sale, the Vendor agreed that it will not become involved in any way with a business in the crane rental industry in Quebec for a period of 5 years from the Closing date or the date which employment with the Purchaser ceased. Payette acknowledged the reasonableness of this clause.

Payette subsequently negotiated employment with the Purchaser beyond the transition period, until he was dismissed without serious reason (or without cause) in August 2009. Payette accepted a position with a competitor of Guay’s in March 2010, and Guay filed a motion for an injunction to have Payette comply with the restrictive covenants in the sale agreement by not working for a competitor for 5 years following his employment with Guay. Payette relied for protection on Article 2095 of the Civil Code of Quebec, which provides that an employer cannot rely on a restrictive covenant where it dismisses an employee without a serious reason. The injunction was denied in the Quebec Superior Court but granted by the Quebec Court of Appeal.

In considering the appeal, the Supreme Court of Canada confirmed that different rules apply to the interpretation of non-competition clauses in the transactional context than in the employment context, and also confirmed that the basis for assessing the reasonableness of the clause is broader in the former context. In order to determine the most appropriate contextual rules to apply where the line between the two is unclear, the Court looks to the nature of the principal obligations and the purpose for assuming them, having regard to the wording of the clause as well as the intention of the parties. In the circumstances of this case, the Court looked at the nature, wording and purpose of the obligations and found that the non-competition clause was more closely linked to the contract for the sale of the assets than the contract of employment. Hence, Payette could not rely on protection of the Civil Code which only applies to a restrictive covenant contained in an employment contract. Further, the reasonableness of the scope, both temporal and territorial, of the covenant was to be assessed against this commercial backdrop. Given the specialized and unique nature of the business in question, the term and territorial scope of the clause was reasonable in the circumstances; Guay had negotiated what was reasonable to properly protect their investment.

From the foregoing, non-competition clauses contained in sale of business agreements where the Vendor becomes an employee of the Purchaser are likely to be enforced, particularly where:

•    the clause is linked to the sale agreement rather than the employment agreement, in light of the wording of the clause (i.e. “in consideration of this sale”) and the circumstances under which it was agreed (i.e. sale of a business);

•    the covenant is contained within the sale agreement rather than the employment agreement;

•    there is evidence that the covenant was designed to protect the assets being purchased, either based on the wording of the clause or the surrounding circumstances;  

•    the covenantor acknowledges the reasonableness of the clause in the sale agreement;

•    the parties are equal in bargaining power, particularly where they have access to legal and financial advice; and

•    the clause is limited in terms of temporal and territorial scope to what is necessary to protect the legitimate interests of the party in whose favour it is granted, and the party bound by the restrictive covenant is unable to establish that the scope of the clause is unreasonable.

Brent Timmons is an Associate with the law firm of BrazeauSeller.LLP.  He practices in the areas of corporate & commercial law, family business and technology law. Brent can be reached at 613-237-4000 ext. 274 or btimmons@brazeauseller.com.  For more information about Brent, please visit www.brazeauseller.com.

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