Bradley v Tech World: Ben's Restrictive Covenant Memo

Alex Bradley, our client, wants to quit his current employment with Tech World to start his own educational software company after some recent disagreements with Tech World's owners, the Duttons. You have asked me to review a restrictive covenant in Bradley's employment agreement to determine whether Bradley can continue to work in the software applications field in the Toronto area after he leaves Tech World. The restrictive covenant is likely unenforceable for two reasons:

1. The clause restricts competition and Tech World cannot show the special circumstances required to justify a non-competition clause as opposed to a less restrictive non-solicitation clause.
2. The clause is unreasonable on two grounds:
   1. It uses ambiguous phrases, including "work of similar duties" and "in any city or municipality in which the Company operates or conducts business" that are prima facie unreasonable in a restrictive covenant.
   2. Its restrictions are too broad since Bradley is prevented from working in businesses that do not compete with Tech World, and he is potentially restricted from working anywhere in North America where Tech World has customers.

I attended the initial client interview and have reviewed your interview notes and the employment agreement. You asked me not to consider whether Bradley has been constructively dismissed.  After discussion with you, I also did not research whether Bradley has already breached the employment contract by developing an educational software package with his wife during his employment term, and whether Tech World may have an intellectual property claim in the new software, although I raise this as a matter for future consideration in the Conclusion and Recommendation.

Bradley anticipates the Duttons will want to block his new venture, and he wants to avoid defending an expensive and time-consuming legal action. I recommend negotiating Bradley's departure, rather than giving the thirty-day's notice required by his contract, starting his new company, and then waiting for the Duttons to come after him.

Facts

Alex Bradley sold Tech World, an Ontario-based software company, to the Duttons two years ago for 3 million dollars. At the time, Bradley told the Duttons that he wanted to scale down his work responsibilities due to his wife's terminal illness. The Duttons, originally Tech World customers from Vancouver, purchased Tech World in order to acquire a toprated research team and to expand their West Coast software business into the Ontario market. The final $500,000 payment on the sale is due on October 15 of this year.

Tech World retained Bradley as Vice President responsible for software research and design of customized business applications. The Duttons moved Tech World's headquarters from Toronto to Vancouver but left the software research team in Toronto under Bradley's direction.

The employment and business sale contracts are separate documents and do not refer to each other. Only the employment contract has a restrictive covenant prohibiting Bradley from performing the same type of duties he does for Tech World anywhere Tech World does business, both during his employment and for three years post termination. The restrictive covenant reads:

The Employee shall not, for any reason, either directly or indirectly, during the term of this agreement, or for a period of three years following the termination of the agreement regardless of how the termination should occur, work performing similar duties to those that he undertook while part of the Company in any city or municipality in which the Company operates or conducts business.

The restrictive covenant's terms are not defined elsewhere in the agreement nor are Bradley's duties defined, except to refer to Bradley as Vice President Research, leading the Toronto-based software team responsible for customized business applications.

Bradley is not involved in Tech World's day-to-day operations and sales. His research and design team creates business application software in consultation with the Duttons. The Duttons' marketing staff refers customers who want customized business applications to Bradley, who then does the initial needs assessment and contract negotiations, and supervises the team that develops, implements, and evaluates the customized application.

Bradley's difficulties at Tech World began eight months ago when he reduced his workweek to two days a week to care for his terminally ill wife, and then took off the two months following her death. During this time, a senior software developer took over direct contact with clients.

In Bradley's absence, the Duttons unilaterally downgraded his responsibilities and authority, moved him to a windowless, inner office, and reassigned his assistant. When Bradley demanded an explanation, Clarence Dutton shouted at him about low productivity and disappearing for two months. Janice Dutton then accused Bradley of misrepresenting Tech World's financial picture during the business sale negotiation. The Duttons are threatening to withhold the $500,000 final instalment on the Tech World sale. Bradley finds the working conditions untenable.

Bradley and his deceased wife developed a new educational program while Bradley was on leave, but still employed by Tech World. This program will be his new educational software company's first product. Bradley's duties in the new corporation would parallel many of his duties at Tech World, although on a different product line. Tech World does not currently sell to the educational market.

 Bradley has no interest in Tech World's clients or continuing in the business applications market. He wants to give Tech World 30-days notice, required by the employment contract, and then set up his new corporation without interference from the Duttons.

Legal Issue

A restrictive covenant prohibits our client, Alex Bradley, from performing duties similar to his current Vice President's duties for three years after his employment, in any city or municipality in which Tech World operates or does business. Does the Bradley-Tech World restrictive covenant meet the standard for an enforceable non-competition clause that must be (1) justified by special circumstances, and (2) unambiguous and reasonable in time, geographic scope, and the activities curtailed?

Brief Answer

Bradley should be able to leave his employment and start his new business without interference by the restrictive covenant.

The restrictive covenant is a non-competition clause and is likely unenforceable for two reasons:

1. There are no special circumstances demonstrating that a non-competition clause, as opposed to a non-solicitation clause, is needed in order to protect the employer's valid proprietary interests. Bradley is not a key employee with exclusive knowledge or contact with customers. The clause does not protect the employer's valid proprietary interests in either its client base or product information because it prevents Bradley from using his skills in any occupation, not just in jobs that compete with the employer's business.
2. The clause is unreasonable and therefore an invalid restraint of trade because it has ambiguous terms and is overly broad in both the activities curtailed ("perform similar duties") and its geographic scope ("in any city or municipality in which the Company operates or conducts business").

Discussion

I. Covenants Not to Compete in Employment Contracts Require Special Circumstances

A. Basic Legal Principles:

The common law treats restrictive covenants in employment contracts as restraints on trade, enforceable only if they are reasonable and in the public interest. Restrictive covenants in employment contracts are scrutinized more closely than those in business sale contracts because the courts presume there is generally an imbalance in the parties' knowledge and bargaining power. A restrictive covenant must not unduly restrain an employee's ability to earn a living in their field. Reasonableness is assessed by taking into account each case's particular circumstances, including the employer's business, the employer's proprietary interests in protecting trade secrets, confidential information and trade connections, and the employee's role.

An employer relying on a restrictive covenant must demonstrate reasonableness under the Supreme Court of Canada's framework in Elsley v J.G. Collins Ins. Agencies, [1978] 2 SCR 916, which requires that:

1. The employer has a proprietary interest entitled to protection.
2. The temporal or spatial restrictions are not too broad.
3. The covenant is not against competition generally but only limits solicitation of former clients.

The Supreme Court further distinguished between non-solicitation clauses that restrict the former employee from contacting clients, and non-competition clauses that keep the former employee out of a profession or business. A non-solicitation clause is likely to be enforced if it protects an employer's proprietary interest and it is reasonable in time and geographic scope. In contrast, a non-competition clause is only enforced in exceptional circumstances when a non-solicitation clause is not sufficient to protect an employer's valid proprietary interest.

If the employer demonstrates that the covenant is reasonable between the parties, then to invalidate the clause, the employee attacking the covenant must show that it unduly suppresses competition and is unenforceable as contrary to the public interest.

Elsley is an example where a non-competition clause was upheld based on the nature of the business and the employee's role. Elsley sold his insurance company to Collins, and concurrently entered into a separate employment contract to manage the business. Both the sales contract and the management contract had non-competition clauses with temporal and geographic limitations.

Elsley managed all aspects of Collins' insurance business for 17 years and was the key contact person for clients to the almost total exclusion of Collins. As general manager, Elsley had access to all the customers' detailed personal and financial information and was in regular contact with them to review their insurance needs. Two months after he left, Elsley started a competing business that attracted a significant number of his employer, Collins', clients. The employer brought an action to enforce the restrictive covenant and for damages. The Supreme Court upheld the validity of the covenant confirming both the trial court and Court of Appeal decisions.

The Supreme Court found first that the employer had a valid proprietary interest in protecting its trade connections and that the contract's restrictions were reasonably limited in time and spatial scope.  The Court then considered whether the nature of the business and Elsley's role justified more than a non-solicitation clause to protect the employer's valid proprietary interest. The Court analogized Elsley's confidential customer relationships to that of a lawyer/client or doctor/patient, making it likely that the employer's customers would follow Elsley when he changed businesses. The Court found that when the parties first contracted, they understood that Elsley would have a close, personal, and exclusive relationships with the employer's customers and the ability to influence them, bringing the case within the exceptional circumstances required to justify a non-competition clause.

As a final point, the Court considered whether the clause would have a negative impact on the public interest. The Court concluded that limiting Elsley's entry into the insurance business in the Niagara region did not unduly constrain competition since there were over twenty-two insurance companies in the region.

In considering whether a non-competition clause is justified by exceptional circumstances, subsequent cases look closely at the scope of the activities curtailed, the nature of the business, and the employee's role in it. For example, in H.L. Staebler Company Limited v Allan, 2008 ONCA 576, the Ontario Court of Appeal overturned a trial court judgment for an injunction and damages for breach of a two-year restrictive covenant prohibiting insurance salesmen from "conduct[ing] business with any clients or customers of H.L. Staebler Company Limited that were handled or serviced by you at the date of your termination." The Court of Appeal held that the clause was a non-competition clause because the employees were prohibited from doing business with former clients, not just from soliciting them. As a non-competition clause, the restriction must be both justified by "exceptional circumstances" and reasonable.

Because the employees were prohibited from doing any business with former clients, regardless of whether the business competed with the employer's insurance business, the clause went beyond what was reasonably necessary to protect Staebler's proprietary interest in its trade connections. Although, like in Elsley, the employees had close relationships with their insurance clients, the Court found that this was the industry norm and did not in itself justify a non-competition clause. The Court found that the employees were regular members of a ten-person sales force with no special knowledge or responsibilities, in contrast to Elsley who was the manager in control of client contacts and considered to be synonymous with the business identity. The Court held that a non-solicitation clause would have been sufficient to protect Staebler's proprietary interest.

Similarly, in Lyons v Multari 2000 Canlii 16851 (On CA), the Ontario Court of Appeal held that an oral surgeon's legitimate proprietary interests did not justify imposing a non-competition agreement on a junior associate who was not the principal contact for patients and was uninvolved in management. The employer's interest in protecting his client base could have been achieved by a non-solicitation clause.

Staebler and Lyons follow the Elsley principles, but reached opposite results based on the courts' close examination of the total employment and business context, and general reluctance to uphold a non-competition clause, unless a non-solicitation clause would be ineffective.

B. The Bradley-Tech World Employment Relationship Does Not Present Special Circumstances.

The clause in our client Bradley's contract is a non-competition clause because it prevents him from doing work similar to what he does for Tech World, for any business, not just for existing Tech World customers. As Vice President overseeing research and design, Bradley has access to software application solutions to Tech World customer's business needs. Tech World has a legitimate proprietary interest in protecting its applications. The key question is whether Tech World can show special circumstances to justify imposing a non-competition clause on Bradley, rather than a non-solicitation clause.

Based on the breadth of the restriction, the nature of the business, and Bradley's role in it, Tech World is unlikely to be able to show special circumstances justifying a non-competition clause. The court is also likely to scrutinize the agreement closely because it is an employment agreement.

i) Breadth of Restriction

Bradley's contract prohibits him from performing, "work with similar duties" to those he does for Tech World. On its face, the phrase prevents Bradley from using his general business, research, design, and supervision skills in any occupation regardless of whether his new work actually competes with Tech World's business. This is the same type of restriction that the Ontario Court of Appeal found unacceptable in H.L. Staebler.

ii) Nature of Tech World's business and Bradley's role

Bradley's circumstances are closer to the employees in Staebler, who were regular members of a ten-person sales force, than to Elsley, who was the de facto face of the business. Tech World's team approach to marketing and software development does not create the type of exclusive personal relationship between Bradley and Tech World's customers that was evident in Elsley. Bradley is not the initial contact with clients. Instead, Tech World's marketing team refers business clients to Bradley, who does the initial needs assessment and contract negotiation. Bradley then supervises the design team in which other team members work directly with the clients to develop and implement the software application packages. During the eight months when Bradley restricted his work to two days a week and then took leave, other employees handled Bradley's duties without disruption.

Further, similar to the facts in Staebler and Lyons, Bradley's Vice President of Research position does not involve him in Tech World's day-to-day operations and sales. In fact, Bradley sold the business in order to extricate himself from management and to limit his role to research and design of custom business applications. This again contrasts with Elsley, where the former owner continued on as the key business manager.

iii) Scrutiny of non-competition clauses in employment agreements

The court is likely to stringently scrutinize the non-competition clause in the employment agreement. Tech World may argue that Bradley and the Duttons were contracting parties with equal bargaining power, and that the non-competition clause in the employment contract is connected to and protects the business purchase. However, the Supreme Court in Elsley rejected a similar argument, viewing the business sale and employment contracts as separately negotiated contracts even though initially the contracts had parallel non-competition clauses. In our client's case, each contract appears to stand on its own; there are no references to Bradley's continued employment in the business sale contract.

When the contract was entered into, the Duttons knew that Bradley was in a vulnerable state – he was caring for his terminally ill wife and that was his express reason for wanting to sell. Also, Bradley told them that he was looking for less responsibility and less involvement in the day-to-day management. Therefore, it is likely that the courts will scrutinize the covenant within the employment contract, separate from the business sale.

In summary, the Bradley-Tech World non-competition clause is unlikely to meet the special circumstance requirement. Overall, in his role as Vice President overseeing the custom software division, Bradley is an important but not an essential employee. The evidence is unlikely to show that Bradley has special knowledge or a special relationship with Tech World's customers to justify a non-competition clause, particularly one that restricts Bradley from working for non-competing businesses.

II. Restrictive Covenants Must Be Reasonable and Unambiguous in Time, Geographic Scope, and Activities Curtailed:

Tech World's clause is likely to fail because the restrictions placed on Bradley's employment activities and the geographic scopes in which he can work are ambiguous and unreasonably broad.

The Supreme Court held that that a restrictive covenant is prima facie an unreasonable restraint of trade if it has an ambiguous term. In Shafron v KRG Insurance Brokers (Western) Inc., 2009 SCC 6, [2009] 1 SCR, the phrase " Metropolitan City of Vancouver" in a three-year non-competition clause was unclear because there was no legal definition or fixed meaning to the phrase's geographical limit.

There are several phrases in Bradley's contract that are arguably ambiguous and too broad. Bradley's contract prohibits him from performing, "work with similar duties" to those he does for Tech World but does not define Bradley's duties except to state he is Vice President Research leading the Toronto-based software team responsible for customized business applications. At a minimum, a clear definition of Bradley's duties is needed to interpret the phrase "similar duties". The ambiguity might be resolved if there is a formal or informal job description, so we need to check this out with Bradley. However, even if there is a job description, the clause is likely to fail as overly broad since it restricts Bradley from working as a team supervisor in any industry, not just software development.

The geographic restriction is also both too vague and too broad.  First, it is unclear what geographic area is meant by the phrase, "any city or municipality in which the employer operates or conducts business". Without a definition of "operates or conducts business", the clause could prevent Bradley from working in any city where Tech World has an office or concludes contracts or simply has customers. Bradley would have no way of verifying whether he can work in a particular location. The language is even more vague than in Shafron, where there was no definition of City of Vancouver. Second, combining the unclear geographic limit with prohibiting Bradley from working anywhere Tech World does business, could restrictBradley from working in the whole of Canada or even North America. In H.L. Staebler Company Limited v Allan, where the clause did not have any geographical limit, the Ontario Court of Appeal noted that spatial restrictions preventing the employees from working anywhere, even if they relocated to the furthest region in Canada, are too broad for an employment agreement. It is against the public interest to unduly prevent employees from pursuing their livelihood.

Conclusion and Recommendation

The restrictive covenant in Bradley's employment contract should not interfere with his plan to start a new business after he leaves Tech World.  As Vice President, Research in charge of the software design team for customized business applications, Bradley performs generic supervisory tasks and more specialised software development tasks; he is not involved in management and marketing, he is not the sole software designer, and he does not deal with clients to the exclusion of Tech World's owners, marketing staff, and other software developers. In short, he is not a pivotal employee. As such it is unlikely that Tech World can demonstrate that there are special circumstances justifying a non-competition clause rather than a non-solicitation clause.

The activities curtailed and the geographic limits imposed in the restrictive covenant are both ambiguously worded and too broad in their reach and thereby likely create invalid restraint in an employment contract. With respect to the ambiguity in Bradley's employment duties, it would be prudent to ask the client if there is a formal job description. However, even with a clear job description, the clause is still overly broad.

An issue that was not covered in the initial interview or in this memo is the possibility that Bradley's work on the educational software program violates the portion of the non-competition clause that says he will not perform similar duties elsewhere during his employment. In the interview, Bradley assumed that his new program was solely his intellectual property because Tech World currently restricts itself to business applications. However, we need to review whether Tech World has any claim on software applications Bradley developed while he was an employee.

Although Bradley has a strong legal case, I recommend that we discuss with him a strategy for negotiating the terms of his departure. Bradley made it clear that he does not want to be distracted by litigation with the Duttons. The Duttons are already threatening to withhold the $500,000 final payment on the business sale and Bradley's departure on 30-days notice may aggravate this situation. Mediation might be a good option, given the significant animosity between the parties. I recommend discussing the negotiation or mediation route with the client at the next meeting.