Restrictive Covenants and the Sale of a Business: Important Decision of the Supreme Court

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On September 12, 2013, the Supreme Court of Canada rendered its decision in Payette v. Guay Inc., 2013 SCC 45. This decision is noteworthy, in that the Court confirmed the principles that apply in determining the reasonableness of restrictive covenants negotiated by the parties in commercial transactions. The Court also appears to have resolved the debate as to whether a non-solicitation clause must be subject to a territorial limitation. Heenan Blaikie successfully represented the respondent Guay Inc. in this matter.

The Facts

In October 2004, Guay Inc. (“Guay”), a company specialized in crane rentals, purchased the assets of a competitor, Groupe Fortier, of which the appellant, Yannick Payette (“Payette”) was a shareholder.

The agreement of sale provided that Payette would work for Guay as a consultant for a period of six months, to ensure a smooth transition; at the end of this period, the parties had the option of agreeing on a contract of employment under which Payette would continue to work for Guay. The parties did so agree, and Payette was employed by Guay until August 3, 2009, at which time he was terminated without cause.

The agreement of sale also included the following undertakings by Payette:

A non-competition undertaking pursuant to which Payette agreed, for a period of five years from the date on which he ceased to be employed, not to be involved in any business operating in whole or in part in the crane rental industry, in the Province of Quebec; and

A non-solicitation covenant pursuant to which he agreed, inter alia, not to solicit any customers of Guay, on behalf of a crane rental business, in any place whatsoever for the same period of time.

On March 29, 2010, Payette entered into an employment agreement with a competitor of Guay. Guay sought an injunction ordering Payette to comply with his non-competition and non-solicitation undertakings.

Relying on the provisions of the Civil Code of Québec that govern the contract of employment, and, in particular, article 2095 which prevents an employer from availing itself of a non-competition clause where it has terminated the employment of the employee without serious reason, the Quebec Superior Court refused to grant the injunction. The Quebec Court of Appeal reversed the decision of the Superior Court, on the basis that the undertakings had been agreed to by Payette in consideration of the sale of assets, and not in consideration of his employment.

The Decision of the Supreme Court of Canada

In a unanimous decision delivered by Justice Wagner, the Court concluded that, to the extent that restrictive covenants are linked to a contract for the sale of a business, rather than to a contract of employment, the scope of the covenants is to be interpreted in light of the rules of commercial law and the protection provided for in article 2095 does not apply.

Restrictive covenants that are linked to a contract for the sale of a business are therefore not subject to the same rules as restrictive covenants that are linked to an employment agreement; in the words of Justice Wagner, the criteria for analyzing restrictive covenants in a contract for the sale of assets will be “less demanding”, and the basis for finding such covenants to be reasonable will be “much broader” in the commercial context than in the context of a contract of employment.

This does not mean that a restrictive covenant that relates to the employment of the vendor and is included in a sale agreement, rather than in an employment agreement, will invariably be lawful. The Court emphasized the importance of clearly identifying the reason why the covenant was entered into and the purpose of the obligations assumed. In Guay, the Court concluded that Payette’s non-competition and non-solicitation undertakings were given in consideration of the sale of his business.

In this context, the criteria used to determine the lawfulness of restrictive covenants in an employment agreement under the Civil Code are not applicable.In the context of a commercial transaction, a restrictive covenant is lawful unless it can be established on a balance of probabilities that its scope is unreasonable, taking into account the circumstances in which it was negotiated. In the view of the Supreme Court, Payette failed to demonstrate that the five-year time period was unreasonable in light of the circumstances.

The Court also concluded as to the reasonableness of the non-solicitation covenant, despite its not containing any territorial limitation. Justice Wagner stated that, in the context of the modern economy and, in particular, of new technologies, where “customers are no longer limited geographically,” a non-solicitation covenant does not necessarily require a territorial limitation in order to be lawful. Indeed, territorial limitations in non-solicitation clauses were described as having “generally become obsolete.”

The clarification of the state of the law in the area of restrictive covenants in Quebec is most welcome. The vendor’s undertakings not to compete with the business that is being sold, and not to solicit its customers, are essential to the purchaser who wishes to protect its investment. The Supreme Court has confirmed that these types of undertakings will be given a much less restrictive interpretation, in the context of the sale of a business, than is the case when dealing with a contract of employment.

Topics:  Canada, Restrictive Covenants, Sales, SCC

Published In: General Business Updates, Labor & Employment Updates

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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