In August 2008, the Ontario Court of Appeal found that the non-competition agreement two employees signed with their former employer was unenforceable. The court ruled that the non-competition clause imposed by the employer went far beyond what was necessary to protect the employer's proprietary interests.
Background
Two employees worked for an insurance company (Staebler) in Waterloo, Ontario, selling commercial insurance to businesses. They began working for the company in 1982 and 1995; when they began employment, they signed an employment agreement containing the following restrictive covenant and damages clause (Clause 10):
“10. In the event of termination of your employment with the Company, you undertake that you will not, for a period of 2 consecutive years following the said termination, conduct business with any clients or customers of H.L. Staebler Company Limited that were handled or serviced by you at the date of your termination.
The damages for any breach of this undertaking shall be a sum equal to 1½ times the commission income received by you or your subsequent employer on account of business conducted on behalf of persons or businesses that were clients/customers of H.L. Staebler Company Limited as at the time of your termination of employment.”
Like all of the other salespersons at Staebler, they sold insurance and earned income based on gross commissions received by the company on the annual renewal of policies.
In 2000, the president and CEO of Staebler decided to restructure the management team. He terminated the vice president of marketing and underwriting and the vice president of finance, and demoted the vice president of sales. He appointed his wife to a newly created position which had the same duties as those of the vice president of sales. Staebler employees were to report to the president's wife.
The employees at Staebler were not happy with the new arrangement. Both of the employees in question were unhappy about the appointment of the new vice president of sales, since they both had approached the president earlier about being considered for senior management positions and were told it was not possible.
Since salespeople developed close relationships with their clients, the company managed the relationships by assigning clients to salespersons and deciding which clients would be gifted when a salesperson retired. By 2003, one of the employees had about 75-100 clients; about half had been gifted to him and the other half was new business that he had developed. The other employee had about 100 clients; only 13 had been gifted to him by a retiring salesperson.
Due to the unhappiness with the recent situation, on October 15, 2003, both of the employees resigned and immediately began performing the same type of work at a new insurance company (Stevenson & Hunt). The employees signed a typical employment agreement containing a standard non-solicitation clause with the new company (the standard non-solicitation clause prohibited the solicitation of clients for 12 months after termination of employment).
By October 29, 2003, about 118 of the employees' clients transferred their business from Staebler to Stevenson & Hunt. Consequently, Staebler claimed that by conducting business with those clients, the employees were in breach of Clause 10 of their employment agreement, and Staebler was thus entitled to damages as set out in the clause. Staebler obtained an injunction preventing the employees from soliciting or accepting business from any Staebler client between October 29, 2003 and October 15, 2005.
Interestingly, Staebler had a clause in the employment agreement of five of its other commercial salespeople that was quite different than Clause 10. That clause stated that the commercial salespeople were allowed to solicit and conduct business with Staebler clients as long as they did not operate within a 50 mile radius of the Waterloo region for two years.
Decision at Trial
The trial judge confirmed that the Staebler book of business was an asset which it owned and was entitled to protect.
The question was whether the restrictive covenant in Clause 10 was reasonable as between the parties. He agreed that it was for the following reasons:
- The employees knew that they would not receive the benefit of gifted clients unless they signed employment contracts with Staebler
- Based on the close personal relationship between the employees and their clients, a non-solicitation clause was not sufficient to protect Staebler's proprietary interest. Clause 10 constituted a “hybrid clause”, a combination of a non-solicitation and a non-competition clause
- The restrictive covenant in Clause 10 was less restrictive than the restrictive covenant in the employment agreement of Stevenson & Hunt
The judge also considered whether the clause was reasonable and in the public interest. He found that it was reasonable since:
· It did not prevent the employees from obtaining lucrative new employment and the new employment was not contingent on the employees bringing clients with them
· The restrictive covenant's two-year duration fell within the industry norm (between 18 months to two years)
Therefore, the judge found that Staebler was entitled to damages against the employees in accordance with the damages provision in Clause 10. The amount of damages actually suffered by Staebler was less than that set out in Clause 10. However, the judge stated that it was not extravagant and unconscionable when compared with what the actual loss could have been.
Also, the judge concluded that Stevenson & Hunt was liable for inducing breach of contract because:
- Staebler had valid and enforceable contracts with the employees
- Stevenson & Hunt was aware of the existence of the contracts
- Stevenson & Hunt intended to and did encourage the employees to breach the contracts
- Staebler suffered damages as a result of the breaches
However, the judge did not find the conduct of Stevenson & Hunt vindictive, reprehensible, malicious or sufficiently oppressive and high-handed to offend the court's sense of decency. He therefore did not award punitive damages against Stevenson & Hunt.
The employees and Stevenson & Hunt appealed the decision.
Decision at the Court of Appeal
The court looked to the test set out in the leading case law. In determining whether the clause was reasonable, the court had to assess the clause, the agreement within which it was found, and all the surrounding circumstances. Then, the court had to ask:
- Did the employer have a proprietary interest entitled to protection?
- Were the temporal or spatial features of the covenant too broad?
- Was the covenant unenforceable as being against competition generally, and not limited to proscribing solicitation of clients of the former employer?
There were also two principles that had to be considered in the assessment:
- Non-competition clauses restrain departing employees from conducting business with former clients and customers. Non-solicitation clauses restrain departing employees from soliciting the business of former clients and customers. The general principle is that a non-solicitation clause is more likely to represent a reasonable balance of the competing interests compared to a non-competition clause. It offers protection for an employer without unduly compromising a person's ability to work in his or her chosen field. Non-competition clauses are only enforced in exceptional circumstances.
- A clause might have been enforceable had it been drafted in narrower terms to make it more reasonable.
The Court of Appeal applied the test to the facts of the case and concluded that the trial judge erred by saying that the restrictive covenant was enforceable.
First, the court looked at Clause 10 itself and decided that it was not a “hybrid clause” as the trial judge had found. Instead, on a plain reading of the clause, it was a non-competition clause. It did not restrain the employees from soliciting, but from conducting business with the former clients or customers.
The court concluded that there were no exceptional circumstances present in the case to warrant the use of a non-competition clause. The fact that the employees enjoyed close relationships with clients or received some gifted clients was ordinary among commercial salespeople. These employees did not play an exceptional role in the Staebler business; they were two of ten salespeople at the company, not managers, directors or key employees. They did not stand in a fiduciary relationship with Staebler.
Also, with regard to the temporal and spatial limits of the restrictive covenant, there was a two-year limit. However, there was no geographical limit (unlike the 50-mile radius limit in Staebler's clauses with other employees). The 50-mile radius clause was significant and raised the question of why these two employees received differential treatment when five other employees had a more reasonable clause in their agreement. Even if the employees moved to the other side of the country, the prohibition still existed. Also, there was no limit in scope or type of work, only a prohibition against “doing business” with the clients or customers. Even if the employees went into a different kind of business, the prohibition against doing business with the clients still existed.
The court also disagreed with the trial judge about Stevenson & Hunt's covenant being more restrictive. In fact, Stevenson & Hunt had a non-solicitation clause limited to prohibiting solicitation for competing services and products. Staebler's unlimited prohibition on conducting business placed a greater restraint on the employees and for a longer period of time.
Finally, other provincial courts also confirmed that suitably restricted non-solicitation clauses were likely to be found to be reasonable for “ordinary salespeople” in the insurance brokerage industry and non-competition clauses were not.
Therefore, Clause 10 was unreasonable. It was overbroad and thus unenforceable. It went beyond that which was reasonably necessary to protect Staebler's proprietary interest. Accordingly, the appeal was allowed and the employees and Stevenson & Hunt were entitled to costs of the appeal and trial.
What can employers take from this case?
The Court of Appeal has sent a strong message to employers-if you are going to use a restrictive covenant, make sure it is reasonable, or else it will not be enforceable and you will not be successful in a claim for an injunction or damages against former employees for breach of contract and competitor companies for inducing breach of contract.
Employers are recommended to review their employment agreements and examine closely the restrictive covenants they contain. Some agreements have a non-competition clause, a non-solicitation clause, or both. Employers are recommended to ask themselves these questions:
- Do I need a restrictive covenant to protect a proprietary interest?
- Do I have a non-solicitation clause, a non-competition clause, both clauses, or no clause at this point?
- Are there extraordinary circumstances involved that could justify the use of a non-competition agreement, or is this a more typical situation that suggests a non-solicitation agreement would be sufficient to protect my interests?
- How can I tailor the clause to be suitable and reasonable in terms of the employment relationship, surrounding circumstances, time period, geography and scope of restriction?
- Now that I have a draft clause, is this prohibition too broad and unreasonable, such that I am limiting the former employee from working in his or her chosen field for too long a period of time in too great a geographical area after termination of the relationship?
- Now that I have a draft clause, and pursuant to a competent legal opinion, should I include it in my employment agreement?
To view the case, visit www.canlii.org.