Scratch That – Court of Appeal Salvages Non-Compete Clause in Agreement for Sale of a Business

A recent case of the Alberta Court of Appeal considered “non-competition” clauses in the context of a purchase and sale of a business.

Background

Restrictive covenants such as non-competition and non-solicitation clauses are often included in employment agreements or separate non-competition agreements. These clauses or agreements purport to limit the ability of an employee to directly compete with, or solicit clients or other employees from, their former employer in the event of a termination. Restrictive covenants are also frequently included as part of agreements for the purchase and sale of a business.

The enforceability of these types of restrictive covenants is a common issue brought before the courts. The general rule is that non-competition and non-solicitation clauses are not enforceable as they are “restraints of trade” which interfere with individual liberty and the free exercise of trade in society.

However, recognizing that restrictive covenants may serve some legitimate purpose in certain cases, if a party can demonstrate that the covenant is reasonable, it may be enforced. A reasonable covenant is one “that 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 favour it was granted” (Payette v Guay Inc., 2013 SCC 45 at para 61).

A covenant will be unreasonable and therefore unenforceable if it is overbroad. An example of an overbroad covenant would be where a covenant restricts an employee from competing in all of Canada, yet the former employer’s operations are limited to the city of Edmonton.

When challenging the enforceability of a restrictive covenant before a court, there are two potential outcomes:

1. The covenant will be found to be reasonable, and will be upheld. The employee will be barred from competing or soliciting in contravention of the terms of the covenant.
2. The covenant will be found to be overbroad and therefore unreasonable and unenforceable. In this situation, the Court has two options:
   1. 1. Find the entirety of the covenant void and unenforceable; or
   1. 1. Apply the doctrine of severance to reduce the scope of the covenant but otherwise leave it intact and enforceable.

The doctrine of severance most commonly applied to restrictive covenants is also known as “blue-pencil severance” as it can only be applied “when the part severed can be removed by running a blue pencil through it” (Shafron v KRG Insurance Brokers (Western) Inc., 2009 SCC 6 at para 29).

The Supreme Court of Canada in Shafron limited the application of severance to covenants contained in employment agreements to rare cases, and only where “the part being removed is clearly severance, trivial and not part of the main purport of the restrictive covenant” (para 36, Shafron).

Whether such a restrictive view of the doctrine of severance would also apply to restrictive covenants contained in an agreement for a purchase and sale of a business was at issue in City Wide Towing v Poole, 2020 ABCA 305, a recent decision of the Alberta Court of Appeal.

Facts of Poole

Devon Poole owned a towing business, Capital Towing (“Capital”), which operated in the Edmonton area. In September of 2017, Mr. Poole entered into an agreement for purchase and sale of the assets of Capital to City Wide Towing and Recovery Service Ltd. (“City Wide”) and commenced employment with City Wide.

Mr. Poole entered into a non-competition agreement (the “Agreement”) as part of the purchase agreement. The Agreement contained a non-competition and a non-solicitation clause with a duration of five years from the date of the purchase agreement, meaning they would be in effect until September 29, 2022. The restrictive covenants in the Agreement were applicable in “Alberta, British Columbia and Saskatchewan” and “any other location within Canada” where City Wide “and its Affiliates are carrying on the Business at any time during the Restriction Period”.

Mr. Poole resigned from City Wide on effectively on June 30, 2018. He commenced work with DRM Recovery Ltd. (“DRM”), a towing company, on July 3, 2018.

In January, 2020, City Wide obtained an injunction prohibiting Mr. Poole from competing with or soliciting clients or business from City Wide in “the Provinces of Alberta, British Columbia or Saskatchewan”. That injunction formed the subject of the appeal.

Enforceability of Restrictive Covenant

The Court of Appeal concluded that, where a restrictive covenant forms part of an agreement for a purchase and sale of a business, the geographic scope of the covenant must generally be limited to the area where the vendor’s business was active, and not where the purchaser’s business was carried out.

In this case, City Wide did carry on business throughout the three provinces named in the Covenant; however, Capital’s business was only carried out in the Edmonton area. As such, the Court found the covenant to be overbroad as it applied to British Columbia, Alberta, and Saskatchewan and therefore unenforceable.

Severance

As the covenants contained in the Agreement were found to be unenforceable, the primary issue before the Court was whether the covenant could be salvaged through an application of the doctrine of severance. On this issue, the court split their decision.

The majority noted that the restrictive approach to severance in employment contracts endorsed by the SCC in Shafron was based on the power imbalance in the relationship between an employer and employee. Public policy favors an “employee’s right to freely carry on her occupation over that of the employer to restrict it unreasonably.”

Those public policy considerations do not necessarily apply to restrictive covenants in the context of a sale of business. In the sale a of a business, as was stated in Ronbar Enterprises Ltd v Green, [1954] 2 All E.R 266: “… it is perfectly proper for the parties, in order to give efficacy to the transaction, to enter into such restrictive provisions as regards competition as are reasonably necessary to enable the purchaser to reap the benefit of that which he has bought…”

The majority cites the British Columbia Court of Appeal decision, ACS Public Sector Solutions Inc. v Courthouse Technologies Ltd., 2005 BCCA 605 as a case where a Canadian court distinguished between vendor/purchaser and employer/employee cases, and held that severance would be more readily applied in the former in order to protect the commercial interests of the parties.

The majority agreed with the holding in ACS and held that the restrictive approach in Shafron was limited to restrictive covenants in the employer/employee context. The majority severed the words “British Columbia or Saskatchewan” from the wording of the covenants, but otherwise upheld the covenant as enforceable.

Interestingly, the restrictive covenant contained a “severability” clause which read, in part: “…should a court determine that any provision or portion of any provision of this Agreement is not reasonable or valid, the parties hereto agree that such provision should be interpreted and enforced to the maximum extent which the court deems reasonable or valid…”. The majority did not comment as to whether or not this provision influenced their decision to apply the doctrine of severance in this case.

Justice Slatter, in his dissent, disagreed with the finding of the majority that severance should be routinely utilized in a commercial context. As he states at para 72: “The role of the court is to interpret and enforce lawful contracts, not to draft contracts for the parties. The remedy of severance should not routinely be granted.” Justice Slatter’s view was that the restrictive approach in Shafron applied to all restrictive covenants. As the covenant in this case was grossly overbroad, including not just British Columbia and Saskatchewan but also many other parts of Canada, he would have declined to apply severance to save the provision.

Take Away

City Wide is a significant case as it will increase the likelihood of Canadian courts applying the doctrine of severance to salvage restrictive covenants in the context of a purchase and sale of a business, even where the covenant as drafted is overbroad and prima facie unenforceable. It does not, however, change the law regarding severance as it applies to covenants between an employer and employee.

In all cases, the safest approach is to carefully tailor the scope of the restrictive covenant to only go so far as is necessary to protect the legitimate interests of the employer or purchaser.

If you or your business requires advice regarding an existing or the drafting of a new restrictive covenant, please contact the author of this article, or a member of our Labour & Employment Team.