Unusual Non-Competition Clause Upheld by B.C. Court of Appeal

April 2014

Previously printed in the CCH’s Focus on Canadian Employment and Equality Rights Newsletter.

Overview

Clauses in employment agreements that preclude an employee from competing with the employer following termination of employment will be struck down as an unlawful restraint on trade and contrary to public policy, unless they can be justified on the basis of reasonableness. In a recent decision, the B.C. Court of Appeal considered a non-competition provision that did not preclude the employee from competing with her former employer post-termination, but imposed a financial obligation on her if she did so. The decision marks the first time that the Court of Appeal has considered whether such a clause constitutes a restraint on trade and the circumstances in which such clauses may be enforced.

Background Facts

In Rhebergen v. Creston Veterinary Clinic Ltd., 2014 BCCA 97, Dr. Rhebergen entered into a three-year employment agreement with the Creston Veterinary Clinic. The employment agreement contained the following provision which did not preclude Dr. Rhebergen from setting up a competing veterinary practice but imposed financial obligations on her if she did so:

NON-COMPETITION

The Associate acknowledges and agrees that she will gain knowledge of and a close working relationship with the CVC’s [Creston Veterinary Clinic Ltd.’s] patients and clients which would injure CVC if made available to a competitor or used for competitive purposes.
The Associate covenants and agrees that in consideration of the investment in her training and the transfer of goodwill by CVC, if at the termination of this contract with CVC she sets up a veterinary practice in Creston, BC or within a twenty-five (25) mile radius in British Columbia of CVC’s place of business in Creston, BC, she will pay CVC the following amounts:

If her practice is set up within one (1) year termination of this contract – $150,000.00;

If her practice is set up within two (2) years termination of this contract – $120,000.00;

If her practice is set up within three (3) years termination of this contract – $90,000.00.

Dr. Rhebergen left the defendant’s veterinary practice after 14 months of employment. She intended to set up her own practice in the Creston area and brought an action in the B.C. Supreme Court seeking to have the non-competition provision declared unenforceable. The trial judge granted the declaration sought, holding that the clause constituted a restraint of trade and was void for uncertainty. In her pleadings, Dr. Rhebergen did not argue that the restriction was ambiguous, but rather took the position that the financial obligations constituted a “penalty” and not a reasonable estimation of liquidated damages and were thus unenforceable. However, at trial, the issue of ambiguity arose and the trial judge ultimately held that the phrase “sets up a veterinary practice” could have a variety of meanings and was an unclear and uncertain definition: was Dr. Rhebergen precluded from establishing an office in the defined area, even though she practised elsewhere, or was she precluded from practising in the defined area, even though her practice was located outside of it? These questions led the trial judge to conclude that the clause was void for uncertainty. In doing so, he relied on the test for post-employment non-competition clauses set out in Aurum Ceramic Dental Laboratories Ltd. v. Hwang (1998), 77 A.C.W.S. (3d) 161 (B.C.S.C):

For a “post-employment” restraint to be enforced, the courts have required the parties seeking to uphold the restraint to prove that the restraint has the following characteristics:

(a) it protects a legitimate proprietary interest of the employer;

(b) the restraint is reasonable between the parties in terms of:

(i) temporal length;

(ii) spatial area covered;

(iii) nature of activities prohibited; and

(iv) overall fairness;

(d) the restraint is reasonable in terms of the public interest with the onus on the party seeking to strike out the restraint.

B.C. Court of Appeal Decision

The B.C. Court of Appeal was called upon to decide two issues: whether the clause in question amounted to a restraint of trade; if so, whether the clause could be enforced, keeping in mind the requirements set out above. In the result, the Court of Appeal was unanimous in holding that the provision constituted a restraint of trade that was per se contrary to public policy and therefore enforceable only if it met the test outlined in Aurum Ceramic Dental Laboratories Ltd. However, the Court was divided on the issue of whether the clause was void for ambiguity. The majority held that it was not. The Court also considered whether the financial obligations imposed by the provision constituted a “penalty” rendering the clause void. The Court of Appeal was unanimous in holding that the payments did not constitute a “penalty”.

There is a divergence of judicial authority in Canada on the question of whether a clause that does not prohibit post-termination competition, but imposes payback obligations, constitutes an unlawful restraint of trade. The Court in this case reviewed judicial authority which took two different approaches to the issue. The first was a “functional approach” in which a court considers whether the clause either attempts to restrain or effectively restrains trade. The second was a more “formalist approach” in which a court considers whether the clause is formally structured as a prohibition against competition as opposed to imposing financial obligations or disincentives if competition occurs.

The functional approach is firmly established in English law, and is reflected in some decisions in British Columbia and Manitoba. On the other hand, there is judicial authority from Ontario favouring the formalistic approach, including a decision of the Ontario Court of Appeal in Inglis v. The Great West Life Assurance Co., [1941] O.R. 305 (C.A.). Under that line of authority, a clause such as the one in question is not an unlawful restraint of trade because it does not prohibit competition.

The B.C. Court of Appeal unanimously sided with the “functional approach” and held as follows:

In my view, the functionalist approach established in English law is to be preferred as the legal basis for determining whether clauses that burden employees with financial consequences, whether by payment or forfeiture, they would not otherwise have for engaging in post-employment competition constitute a restraint on trade.

Accordingly, clauses that impose an obligation to repay training expenses or other employment-related costs in the event of post-employment competition would constitute a restraint of trade.

In assessing whether the payment obligation in this case constituted a penalty, the Court of Appeal considered the facts. They demonstrated that the amounts were arrived at by the defendant assessing the costs it would incur during Dr. Rhebergen’s employment in training, mentoring and providing equipment, and factoring in both the plaintiff’s salary and the impact on the clinic’s goodwill and volume of business if she were to leave and set up a competing practice. The reduction in the payment amounts reflected the fact that less business would be lost if there was a delay between the termination of the contract and the setting up of Dr. Rhebergen’s practice. In determining whether the amounts constitute a penalty, the test applied by the Court was whether it could be said that the amounts were “extravagant and unconscionable in comparison with the greatest costs to the clinic that could be proved”. The Court of Appeal unanimously held that the test was not met and accordingly the amounts stipulated did not constitute a penalty.

On the question of ambiguity, the dissenting judge agreed with the trial judge that the precondition that the plaintiff “set up a practice” was void for uncertainty. In brief reasons, the majority held that in the context of the facts, the plain and ordinary meaning of the words “to set up a practice” meant a continuous or regular provision of veterinary services by Dr. Rhebergen in the defined area, no matter where she located her practice. The plaintiff had claimed in her pleadings that she intended “to set up a mobile dairy veterinary practice in Creston, BC and vicinity” and the majority concluded that the clause had been triggered.

While a court generally endeavours to resolve ambiguities in order to determine the mutual intent of parties to a contract, an exceptional degree of clarity is required in clauses that constitute a restraint of trade. The Court accepted that such clauses will be more strictly construed against the employer in an employment context than they will be in the context of a sale of business.

Lessons for Employers

There are a number of lessons for employers to draw from this decision:

A provision in an employment contract that provides a financial disincentive for competition post-termination will likely be viewed as a restraint of trade requiring the employer to justify all aspects of the provision on the basis of reasonableness.
Clarity and certainty are required to enforce an otherwise reasonable non-competition provision. In this case, ambiguity arose out of the phrase “set up a veterinary practice” which could easily have been avoided by using the phrase “engaged in veterinary practice”.
Any financial obligation imposed on an employee who competes post-employment must be defensible as a reasonable estimation of liquidated damages or expenses incurred, and must not constitute a “penalty”.