You Can’t Do That – The Ins and Outs of Non-Competition Clauses

Author: vtsui@businesslawgix.com

Date: APR 1st, 2014

Topic: Industry Experts

“Restrictive Covenants” is a fancy term meaning “promises that restrict or limit activities”. Restrictive covenants typically include non-solicitation clauses and non-competition clauses. Here, we will focus on non-competition clauses.

You might say “I know what non-competition clauses are! They keep me from competing with a business.” While that may be their general intent, the way that such clauses are often drafted makes their application much wider.

It is commonly believed that to “compete” means only to run or operate a business that sells the same wares or provides the same services as the original business. The fact is, many non-competition clauses are drafted such that to “compete” also means to own, to lend money to, to give advice to, to work for, to be a guarantor for, to lend your name to, or to have any interest in, a competing business. In addition, most non-competition clauses capture such activities whether you do them personally, through a corporation, a partnership, or through any other entity or capacity. For example, if you are subject to a non-competition clause and your spouse (with your covert assistance) incorporates and operates a competitive business, then you might be in violation of your non-competition obligations. In Ontario, Pet Valu Canada Inc. successfully sued a former franchisee for exactly such a scenario.

In order to not compete, you need to understand what constitutes a “competitive” business. Competition clauses are often drafted broadly. As such, other than in the most obvious scenarios, it is often difficult to discern what is in fact a “competitive” business. Some non-competition clauses may describe the prohibited businesses as “businesses that are competitive”; which is not helpful at all. Sometimes, you may see references to businesses “that are the same as or similar to” the subject business. While such verbiage provides a bit more direction, it raises the question as to how “similar” would a business have to be to qualify as a “competitive business”. A well-drafted non-competition provision will be specific as to what constitutes a competitive business.

Another aspect of a non-competition clause is the temporal element. As the term suggests, the temporal element relates to how long the non-competition prohibition will apply. Typically the temporal element involves two distinct durations; the period during which the contract in question is in effect, and a period after the termination or expiration of the contract. Related to the temporal element is the geographic element, which is the geographic area within which the non-competition prohibition would apply. Most disputes relating to the temporal element relate to the duration after the termination or expiration of the contract; in particular the reasonableness of such duration. Likewise, the reasonableness of the geographic restriction is the focus of most disputes relating to non-competition clauses.

Restrictive covenants are generally considered a restraint of trade. They are deemed to be unenforceable unless they are necessary and reasonable to protect the interests of the party they are designed to protect. Therefore, to analyze a non-competition clause, the starting point is whether such a prohibition is necessary. Are there other less onerous ways (such as confidentiality or non-solicitation obligations) to achieve the protection sought? If such prohibition is necessary, then consider whether the restrictions being imposed are reasonable.

Unfortunately, what is “reasonable” cannot always be objectively determined. It will depend on a number of factors from the contracting relationship to the interests that the non-competition provisions are designed to protect. Reasonableness must necessarily be assessed on a case-by-case basis. This is yet another reason why it is prudent to obtain legal advice from a qualified lawyer before entering into any contract.

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