Non-Competition Clauses In The Purchase Or Sale Of A Business

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is a litigation lawyer practicing at Perley-Robertson, Hill & McDougall LLP in Ottawa, Ontario. He may be reached at 613.566.2823 or obourns@perlaw.ca.

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Non-competition clauses are often discussed in the employment law context.  However, they can be equally, if not moreso, important in the purchase or sale of a business.

When selling or purchasing a business, large or small, a key consideration will be whether the outgoing owner should be governed by a non-competition clause, otherwise known as a restrictive covenant.  This issue cuts across just about all industries be it the high tech or service industries.

For the buying party a non-competition agreement is important on its face.  The last thing a purchaser wants to see is the outgoing owner walk across the street and open up or join a pre-existing competing business.  Such an event could cripple the purchased business and nullify any goodwill supposedly gained in the transaction.

For the selling party such a clause may be desirable to increase the value of the sale.  For the reasons above the purchaser may be willing to pay significantly more for the business if they are reassured the seller will refrain from competing.

The concern in drafting non-competition clauses, especially for the purchaser, is the enforceability of the covenant.  An unreasonably restrictive non-competition clause will be found to be an unenforceable restraint of trade in either the employment or sale of business context.

The different treatment of non-competition agreements in employment law contracts versus agreements for the sale of a business relates to the difference in the bargaining power of the parties in the circumstances.  While an employee often has little say in terms of what goes into their employment contract, the seller of a business will normally negotiate the terms of the sale carefully and will be compensated in the purchase price accordingly.

In the purchase of a business the buyer will normally be seeking to protect the goodwill associated with the business.  The non-competition clause should not go further than is reasonably adequate to give the necessary protection to the business’ goodwill.  In determining whether a clause is reasonable the courts will examine; (a) the activities sought to be restricted, (b) the geographic area of restrictions, and (c) the duration of the restriction.

In the employment context it is clear that a non-competition clause lacking either a geographical or temporal limitation will render the clause completely unenforceable.  In RG Insurance Brokers, 2009 SCC 6 the Supreme Court of Canada found that it was not appropriate for the court to take an overly broad or ambiguous non-competition covenant and rewrite the clause to make it reasonable.

The case law on non-competition clauses within contracts for the sale of a business is far less developed.  However, what is clear is that reliance on the terms of the contract as an indication of what is reasonable in the circumstances is on the rise.

In Capital Safe & Lock Service Ltd. (2000) 230 N.B.R. (2d) 117 the New Brunswick Court of Appeal upheald a 10 year / 100 mile restriction.  Justice Drapeau stated that when considering the reasonableness of a non-competition clause in the sale of a business the courts will examine that both the temporal and geographic restrictions are no greater than what is required to protect the buyer’s proprietary interest.  However, unlike in the employment context, there will be deference for the wishes of the parties as expressed in the contract.

In KRG Insurance Brokers, the Supreme Court went out of its way to explain that the freedom of contract involved in the sale of business means that non-competition clauses in that context will be less rigorously scrutinized than restrictive covenants in employment contracts.

Unlike in the employment law context, in arguing that the non-competition clause is reasonable the purchaser will more readily be able to simply point to the contract – perhaps subject to outrageous and unnecessary geographic and temporal restrictions.  The higher the perception of an equality of bargaining power between the parties will increase the likelihood the courts will find the clause to be reasonable.

Conversely, in attempting to avoid enforcement of a non-competition clause a seller will then need to show that the enforcement of the clause would be injurious to the public interest.  It is a very difficult argument to make that the public interest is injured by the enforcement of business agreements arrived at between parties of equal bargaining power.

What remains to be seen is how the lower courts will interpret the Supreme Court’s clear distinction between non-competition clauses in the employment and sale of business realms.  It seems as though the freedom to contract more restrictive non-competition covenants in the context of a sale of business may be upon us.

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Owen Bourns is a litigation lawyer in Ottawa, Ontario.  He may be reached at 613.566.2823 or at obourns@perlaw.ca.

 

1 comments
williamroyee
williamroyee

Good post, thanks for clarifying the distinct areas in the non-compete agreements in employment and in a sale of a business. It can be difficult for a seller whose focus or knowledge in this type of transaction is primarily on how much he will earn from it. Unless we’re talking about the sale of huge company, most sellers aren’t as aware as they should be about this part of the selling and buying process. Small- and medium-scale business owners are generally in-the-know about non-compete clauses, but don’t usually pay attention to these details.

That being said, I think it’s important for sellers of their business to find out about what the sale entails, as detailed here http://www.globalbx.com/a_Non-Competition-Non-Compete-Agreements-When-Selling-A-Business.asp. Apparently, it’s more than just finding people or a group of people to take over your venture and you making money out of it. Months or years later, you may want to put up the same kind of business but the contract (and the law) won’t allow that for a specific period of time.

Someone told me the non-compete clause t almost feels like being restricted from doing what you already know or are good at. You need to understand that it is integral to the sale of a business, so make sure you have Plan B (other type of business or source of income) before you seal that deal.