Crane Rental Operater Hoisted by Restrictive Covenants
November 11th, 2013
Non-compete and non-solicit clauses are presumptively valid when connected to an agreement for purchase and sale of a business, the Supreme Court confirmed recently. While such sales may also give rise to an employment agreement, the obligations of the parties are usually primarily linked to the commercial contract, and thus any restrictive covenants should be afforded broad interpretation. The decision, Payette v. Guay inc., provides a clear and coherent analysis for determining the rules of interpretation to be applied to restrictive covenants that arise in these hybrid contracts.
The respondent Guay operated a crane rental company in locations across Quebec. In October 2004, Guay purchased the assets of the appellant Payette, who controlled several companies that were also in the crane rental business, for $26 million. The agreement for the sale of assets contained non-competition and non-solicitation clauses (the “restrictive covenants”). As well, Payette agreed to work for Guay as a consultant for six months, with the possibility of extending his employment further. At the end of this transition period, the parties agreed on a contract of employment for an indefinite term. A few years later, Guay dismissed Payette without a serious reason. Payette then started a new job with a competitor business, leading Guay to seek enforcement of the restrictive covenants.
In the Quebec Superior Court, Guay’s motion for an injunction compelling Payette to comply with the restrictive covenants was dismissed. Justice Lemelin held that the non-solicit and non-compete clauses were linked to the contract of employment, and thus fell under the specific protections of article 2095 of the Civil Code of Quebec. Under that article, a Quebec employer cannot rely on a non-compete clause if he has terminated the employee “without a serious reason”. However, the majority of the Court of Appeal set aside this judgment and ordered a permanent injunction, finding that the obligations of the non-solicit and non-compete clauses were assumed by Guay under the commercial sale agreement, not the employment agreement. Under the rules applicable to the sale of a business, and not those applicable to contracts of employment, the clauses were found to be reasonable and lawful. Payette then appealed to the Supreme Court of Canada.
Employment vs Commercial Contract
It has long been accepted that the rules applicable to the enforceability of restrictive covenants differ depending on whether they are linked to a contract for the sale of a business, or to a contract of employment . Restrictive covenants in employment agreements are generally given a rather narrow scope, in response to the imbalance of negotiating power between an employee (who wants the job) and an employer (who has the job to give). Such an imbalance of power is not presumed to exist in a vendor-purchaser relationship, where parties are usually more sophisticated and well informed about the obligations they are undertaking. As such, restrictive covenants in commercial contracts are generally interpreted and enforced more broadly than those in employment agreements. In order to determine whether the restrictive covenants were enforceable, the court thus had to first determine whether they were linked to the purchase and sale of Payette’s business, or the resulting employment from which he was terminated.
To Which Contract were the Restrictive Covenants Linked?
In order to determine whether the restrictive covenants were linked to the contract for the sale of assets or to the contract of employment, the court had to identify the reason the covenants were entered into. To do this, they considered two main factors: the wording of the clauses, and the context in which they were agreed upon.
The non-competition clause began with the words “in consideration of the sale that is the subject of this offer”. Article 10.4 of the contract, acknowledging the reasonableness of the restrictive covenants, contained the phrase “having regard to the consideration provided for herein”. Overall, on a plain reading of the language used, the court held that the restrictive covenants were accepted by Mr. Payette “in consideration of the substantial advantages he would be depriving from the transaction, not of his potential status as an employee”.
Secondly, the court examined the context in which these covenants were negotiated. The main motivation for the sale was to enable the respondent Guay to acquire the vendor’s goodwill, skilled employees and customers. If he had not obtained the protection of the restrictive covenants, the sale would never have happened, as there would have been nothing to prevent the vendor from simply stealing back their clients and employees the next day under the guise of a new company. Thus, there was a direct causal connection between the restrictive covenants and the sale of the assets, not the subsequent employment.
Finally, the court dismissed the appellant’s argument that the covenants were linked to Payette’s employment contract simply because they make specific reference to the termination of his employment. Rather, this reference to termination of employment was only a “guidepost” for establishing the period during which the non-competition covenant was to remain in effect. This did not change the essence of the obligation as being one connected to the sale of assets.
Were they Enforceable?
As the Court found that the restrictive covenants were linked to the commercial sale contract, rather than the employment agreement, the Civil Code of Quebec protections did not apply. The burden of proof was therefore on the vendor, Payette, to prove on a balance of probabilities that the scope of the clauses was unreasonable. As discussed above, the reasonableness of a restrictive covenant is more broadly interpreted in the commercial context than in the employment context. Looking to the non-compete clause first, the court stated the test thus:
A non-competition covenant will be found to be reasonable and lawful provided that it 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.
Factors a court will consider include:
- Sale price
- Nature of the business’ activities
- The parties’ experience and expertise
- Whether the parties had access to legal counsel and other professionals
- The circumstances of the negotiations
- Extent of the resources to which the parties had access at the time
In this case, the agreement was for $26 million, and followed lengthy negotiations between well-informed businessmen who were on equal terms and were being advised by legal and accounting professionals. Given those factors and considering the highly specialized nature of the business, the court found no evidence that a 5-year term was unreasonable. In fact, the court cited a number of instances in which the Quebec courts have enforced terms twice that length.
The territorial scope of a restrictive covenant must be limited to that in which the business being sold carries on its trade or activities as of the date of the transaction. In this case, the clause applied to the entire province of Quebec. While this is a considerable area, the court found that due to the unique nature of the mobile crane rental business, the territory to which the non-competition covenant applied was not unreasonably broad, and thus was valid.
Turning to the non-solicitation clause, the court explained that such covenants do not generally require territorial limitations to be considered reasonable. The scope of such clauses can generally be ascertained from simply looking to the vendor’s client lists. As well, due to changes in technology, customers are often not limited geographically, meaning that such territorial limitations have generally become obsolete. The non-solicit was found to be reasonable and thus enforceable as against the appellant.
In sum, the Court found that the non-solicitation and non-competition clauses arose from the purchase and sale of Payette’s business, not his subsequent employment, and were reasonable in all the circumstances. At paragraph 9, Justice Wagner dismissed the appellant’s position as untenable, stating:
The effect of disregarding the existence of such clauses solely because they appear in an agreement that preceded the formation of a separate contract of employment would be to negate the foundations of, and the rationale for, the obligations of non-competition and non-solicitation provided for in the clauses, while at the same time discounting the intentions of the parties.
Justice Wagner’s reasoning will prove useful to parties seeking to enforce restrictive covenants against a vendor who also becomes an employee in the course of a sale of business. While the dispute arose in the context of a specific Civil Code of Quebec provision, the analysis should prove applicable to disputes under the common law as well.