by Brian Smeenk
In an important recent decision, Ontario’s Court of Appeal has reconfirmed that noncompetition clauses will be enforced against departing employees only in exceptional circumstances. It allowed two insurance salespersons to take many of their clients to a competing insurance broker despite their contractual agreement to the contrary.
What happened?
Tim Allan and Jeff Kienapple worked for H.L. Staebler Company Limited. They sold commercial insurance (property, casualty, and automobile) to businesses. Because they were unhappy with new management, they resigned and immediately began working in a similar capacity for Stevenson & Hunt Insurance Brokers.
Both of the employees had written employment contracts with Staebler. The contracts contained a restrictive covenant that stipulated that for two years after the termination of employment, they were not to “conduct business with any clients or customers of . . . Staebler that were handled or serviced by you at the date of your termination.”
Staebler sued the employees and their new employer, Stevenson & Hunt (H. L. Staebler Company Limited vs. Allan et al. [2008]). Staebler first obtained an injunction preventing the employees and Stevenson & Hunt from soliciting their customers. By that date, approximately 118 clients had moved their business from Staebler to Stevenson & Hunt. Later, after a 13-day trial, the employees and Stevenson & Hunt were ordered to pay Staebler approximately $2 million in damages. This was on the basis that the restrictive covenant was found to be reasonable and enforceable.
The employees and their new employer successfully appealed to the Ontario Court of Appeal. A panel of three appeal court judges unanimously found that the restrictive covenant in the employees’ contracts was not reasonable and not enforceable. There was therefore no restriction on the employees’ ability to compete with their former employer.
Background
The evidence established the following. Staebler is a well-established, regional insurance broker that sells commercial, personal, and group benefits insurance in the region of Waterloo, Ontario. In 2003, Staebler had over 50 employees, at least 12,000 clients, and $5.5 million in annual sales. Allan and Kienapple began employment with Staebler in 1982 and 1995 respectively. Their role was no different than that of any other salespersons selling commercial insurance at Staebler.
In 2003, Allan had between 75 and 100 clients. Half had been “gifted” to him by management, and the other half was new business that he had developed. Kienapple had 100 clients. Thirteen had been “gifted” to him. Of the balance, some were part of a book of business that he had sold to Staebler in 1995. The court found that the employees would not have been hired and received gifted clients without signing the restrictive covenant.
Salespeople in the insurance brokerage industry develop close relationships with their clients. Staebler managed these relationships by assigning clients to salespersons and by deciding to whom clients would be “gifted” when a salesperson retired. It also controlled the marketing, billing, client finances, and relationships with insurance companies.
At Staebler, a number of different employees provided services to a commercial salesperson’s clients. Customer service representatives frequently dealt with clients. Commercial marketers negotiated clients’ contracts with the insurance companies. Sales staff other than the departing employees sold personal and group benefits insurance to the same clients.
On October 15, 2003, the two employees resigned from Staebler and immediately began working for Stevenson & Hunt. They solicited their former clients, clearly in breach of their contracts with Staebler, taking the position that the restrictive covenants in those contracts were not enforceable. Within two weeks, they convinced 118 customers to transfer their business.
Appeal court’s statement of applicable principles
In quashing the trial decision in favor of Staebler, the appeal court restated the following key legal principles governing the analysis of restrictive covenants like noncompetition and nonsolicitation clauses in employment agreements:
- Such an agreement is enforceable only if it is “reasonable between the parties and with reference to the public interest.”
- There is an important public interest in discouraging restraints on trade and encouraging open competition.
- On the other hand, the courts do not want to restrict parties’ right to contract, particularly where there is equal bargaining power.
- The courts also seek to provide reasonable protection to trade secrets, confidential information, and the trade connections of employers.
- In considering whether a restrictive covenant is reasonable, the courts will consider:
- the entire agreement in which the clause is found and the surrounding circumstances;
- whether the employer has a proprietary interest entitled to protection;
- the time period during and geographic area in which the clause applies; and
- whether the clause prohibits competition or just solicitation of clients.
- In looking at the last factor, the court emphasized that nonsolicitation clauses are normally sufficient to protect an employer’s proprietary interests. Noncompetition clauses are warranted only in exceptional cases, where a nonsolicitation clause will not be effective to protect the employer. But even nonsolicitation clauses should be limited in their duration and geographic scope.
- The fact that a clause might have been enforceable if it had been drafted more narrowly will not save it. The question is whether or not a valid agreement has been made.
How the principles were applied here
The appeal court disagreed with the trial judge about the reasonableness of the restrictive covenant in this case. It found that the restriction in question was a true noncompetition clause. The exceptional circumstances that might allow for such a restriction were found not to exist. The employees were “ordinary salespeople” who did not play an exceptional role in Staebler’s business. They were not managers or key employees.
Although there was no dispute that Staebler had a proprietary interest to protect — its book of business — the court found that the clause was unreasonable in that it had no geographical restriction. The clause purported to prohibit the employees from doing business anywhere with their former clients, “even if they relocated to the far reaches of Ontario or, for that matter, elsewhere in Canada.”
Furthermore, the court was concerned that there was no limit in the clause on the type of work that the employees were prohibited from conducting. The prohibition was against doing “business” with former Staebler’s clients, and thus would extend to any form of business. This went well beyond protecting Staebler’s trade connections.
Finally, the court reiterated that for “ordinary salespeople” at least, a nonsolicitation clause that is suitably restricted would have been sufficient to protect the employer’s proprietary interests.
For all of these reasons, the restrictive covenant in question was not enforceable. The $2 million damages award was set aside.
Importance of this decision
This decision, by Ontario’s highest court, applies principles established in earlier cases by the Supreme Court of Canada. It will likely be influential in similar cases across Canada, as these principles are of general application.
This decision serves to emphasize that noncompetition clauses in the employment context will be enforced by the courts only in exceptional circumstances. The onus will be on the party seeking to enforce such a clause that the case is exceptional, and that a nonsolicitation clause would not be adequate to protect its proprietary interests.
It remains to be seen whether agreeing expressly in a contract that the situation is exceptional would influence the court’s conclusion. Given a number of cases, including this one, where the courts have expressed concern about the unequal bargaining power that often exists between an employer and employees, a finding of such inequality (which sometimes seems to be a presumption, rather than a finding based on evidence) may well lead the courts to decline to uphold even express agreements to the effect that a situation is so exceptional that a noncompetition clause is reasonable.
This decision also emphasizes that even nonsolicitation clauses must be limited reasonably in terms of their geographic scope and duration. They should be limited to that which is necessary to protect the employer’s proprietary interests while not unduly limiting competition or the employee’s ability to earn a living.
Finally, it is clear that an unreasonable clause restricting an employee’s postemployment activities will be completely unenforceable. The court will not selectively apply those portions that it finds to be reasonable.
In short, restrictive clauses in employment agreements must be very carefully drafted. It is a mistake to overreach.
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