Northern Exposure

Should Noncompete Agreement Be in Purchase and Sale Agreement or in Employment Agreement?

By Chris Semerjian

When Canadian employers are buying other businesses, the question of noncompetes often arises. But a noncompetition provision in an employment contract may not be the answer.

According to the Quebec Court of Appeal in Guay Inc. c. Payette, 2011 QCCA 2282, you may be better protected by only having a noncompetition covenant in your sale agreement rather than also including such a clause in your new employees’ employment contracts.

In October 2004, Guay Inc. bought the assets of the company controlled by Payette for $26 million. Pursuant to the purchase and sale agreement, Payette was hired as a consultant for a period of six months. The purchase and sale agreement also included a noncompetition clause prohibiting Payette from competing with Guay in Quebec for a period of five years after his consulting relationship ended.

Six months later, Payette was hired by Guay as a director. His employment contract with Guay didn’t include a noncompetition clause.

In August 2008, Guay terminated Payette’s employment. In March 2010, Payette was hired by one of Guay’s competitors, where he was followed by seven of Guay’s employees.

Guay asked the Superior Court of Quebec to issue an interlocutory injunction preventing Payette from joining the ranks of its competitor. The outcome of the case depended on the nature of the noncompetition agreement.

Employment vs. sales agreement
There are important distinctions between a noncompetition agreement found in an employment contract and one found in a purchase and sale agreement.

The first distinction, at least in Quebec, is that the provisions of the Civil Code of Quebec governing employment contracts don’t apply to sales agreements. As such, Section 2095 of the Code, which prohibits an employer from benefiting from a noncompetition clause if it terminates the employment contract without a serious reason, doesn’t apply. Section 2089 of the Code, which imposes on the employer the burden of proving that the noncompetition is valid, also won’t apply to a sales agreement.

The second and more general distinction derives from the imbalance that exists in an employer-employee relationship that isn’t usually found in the buyer-seller relationship. Although to be valid both types of noncompetition agreements need to be limited in time, in space, and in the restricted activities, courts show more latitude when the restrictions are contained in a purchase and sale agreement.

Part of an employment contract?
In Guay, the Superior Court said that the parties had the intention to create an employment contract in the purchase and sale agreement. As such, the noncompetition covenant was in fact part of an employment contract. Because Payette’s employment was terminated without cause, the trial judge ruled that Guay couldn’t claim the protection of the noncompetition agreement, which, in any event, contained limits that were too broad for an employment contract.

Or part of a sales agreement?
The case then proceeded to the Quebec Court of Appeal. It said that one must determine the reason that motivated the parties to enter into a noncompetition agreement. A noncompete clause would either have to fall under the regime governing purchase and sale agreements or under the regime governing employment contracts.

In the case at hand, the Court of Appeal determined that the real reason behind the noncompetition clause was the purchase and sale agreement. Indeed, Guay’s real interest in prohibiting Payette from competing didn’t stem from Payette’s employment but rather from the $26 million investment made by Guay as part of the purchase and sale agreement.

Further, the fact that Payette’s employment contract didn’t contain a noncompetition agreement was a clear indication that the motivation behind the noncompetition agreement was the sales agreement.

In the end, the Court of Appeal overruled the trial judge and ruled that the noncompete clause was valid. Payette is appealing to the Supreme Court of Canada.

Recommendations to employers

If the Supreme Court of Canada agrees with the Court of Appeal, employers that wish to acquire a competitor’s business and employees may be better protected with only a noncompetition clause in the purchase and sale agreement rather than by adding another noncompete clause in an employment contract. Given the similarity of case law pertaining to noncompetition clauses across the country, this decision might also affect companies looking to acquire a competitor located in the rest of Canada.