Negative Covenants in an Employment Contract

Written on behalf of Peter McSherry

Negative Covenants in Employment Contracts

A negative covenant, also known as a restrictive covenant, is a term in an employment contract which states that the employee “shall not do” certain things following the end of employment.

There are three popular types of covenants which restrain a person’s ability to carry on competitive employment, which are collectively referred to as “restrictive covenants”. These are:

• non-competition clause;
• non-solicitation clause ; and
• a confidentiality clause.

Negative covenants are used as a tool by which an employer attempts to protect its business interests, its customer base, confidential information, trade secrets, and its alleged propriety methods of doing business from past employees.

Just because these words appear in a contract does not mean that the terms are enforceable. In fact, in Ontario, all such terms are presumed to be void unless the employer can prove otherwise.

Non-Competition Clauses and Non-Solicitation Clauses: All Covenants Presumed Void

The employer seeking to enforce such covenants must pass a rigorous test to show why it requires such protection. The most difficult test to pass is that of the non-competition covenant, since such a term purports to stop an employee from competing with the business of the employer.

Often the employer will seek to use a non-competition term when a non-solicit would be an adequate means of protecting the employer’s interests. Generally, an non-solicit covenant is less demanding, as it typically requires an employee to refrain from soliciting business of the past employer, and/or from soliciting past employees or soliciting business with the suppliers of the former employer.  Accordingly, such a covenant does not attempt to ban competition, but rather to control it.  However, while a non-solicit term may, on its face, be less restrictive than an non-competition covenant, a non-solicit covenant must be used carefully by the employer since an overly ambitious restriction will lead to the demise of the protection that has been intended.

By example, a non-solicit term which restrains the employee from not only soliciting business but also accepting business will be viewed as a non-competition covenant and will face the more difficult test of enforcement. Similarly, the creation of a more encompassing form of a non-solicit  which is not related to the actual business activities of the departed employee, but for example, purports to prevent the employee from soliciting business from “any client” of the employer, as opposed to clients known to him, will fail.

Generally speaking, the more precise the non-solicit may be and the more limiting its words are set to be, the greater likelihood is that it will be enforced.

Often, it is the foolhardy employer who believes that the non-competition tool which will provide it the most effective protection. The reality is that the enforcement of a non-competition covenant is very difficult and very likely to fail. There are yet many other tools at the disposal of a creative employer, apart from the non-competition and non-solicit covenants.

Examples of Enforceable Terms

For example, a contract which contains the following terms will very likely be enforced:

1. Allows competition but creates an agreed financial damage sum to be repaid. This will be effective as long as the damage sums are genuine and realistic. It still must pass the difficult test of why the employer should be protected by a restrictive covenant.
2. Creates a form of contingent compensation which the employee will earn over a fixed time period while employed, or attach the earning of this sum to compliance with an agreed notice period from the employee to the company. The compensation must not be earned, but rather be earned over the relevant time. This term will not be considered a restrictive covenant. The sum must not be earned income as such would likely be construed as a penalty clause and unenforceable.
3. A variation of the above is to pay such deferred contingent compensation pending compliance to the non-competition or non-solicit. This will need to pass the test of a non-competition covenant.
4. Attach the non-compete term, more preferably the non-solicit, to payment of an agreed severance over time to ensure compliance with its restrictions. Any statutory sums must be exempted from this or this term will fail. This also will be viewed as a non-compete.
5. Contract for, and enforce, a notice obligation from the employee to the company independent of any other covenants.

Permissive Clauses

In some cases, employment contracts seek to endorse competition, albeit with some form of financial impediment, rather than attempt to ban or control competition. .

Such clauses generally take three forms:

1. Providing for a direct financial loss to be paid to the employer; or
2. Allowing for a defined payment otherwise due to the employee to be deferred pending compliance with post-termination activities; or
3. Mandating training or other expenses be repaid.

The general review of such clauses involves firstly the question of whether the subject matter is a restrictive covenant or otherwise. In all likelihood, the real ambition of the employer is not the collection of money but the imposition of a reality check as to whether the contemplated new competitive business is worth the pain upon the apparent offender.

These clauses are generally much more likely to be enforced.

Confidentiality Covenant

The purpose of a confidentiality clause is to place restrictions on what information is prohibited from being used by the employer following the end of employment.

As is the case with other forms of negative covenants, a confidentiality clause is also presumed unenforceable at the outset of the analysis, albeit with the caveat that it is often an easier clause to enforce as there is no need to establish a “public interest” component.

Ultimately, as with other restrictive covenants, a confidentiality clause which is overly ambitious will run the risk of an adverse court finding that it is in unreasonable and hence unenforceable.

Reasonable restrictions as to the use of trade secrets, confidential information, and trade connections will be upheld.

The information at issue may be considered confidential for the purposes of the action before it. To pass the test of confidential information in the covenant, these issues will be considered:

1. There must be the presence of confidence in the protected material;
2. The extent to which the information is known outside the business;
3. The extent to which the information is known by employees and others within the business;
4. The extent of protective measures taken by the owner;
5. The value of the information to the business and its competitors;
6. The financial investment made by the business to develop the information sought to be protected;
7. The degree of difficulty or lack thereof for others to acquire this information by legitimate independent means.

If the information meets the test of confidentiality and reasonable limitations are imposed, a term will likely be enforceable.

Take Advice on Your Contract

The law on this subject is complex and very fact-specific. The risks of violating a valid negative covenant are considerable. The limitations on your ability to earn a livelihood are also real and upsetting. All employees are urged to consult with an employment lawyer before signing any contract and also before  taking any action following termination.

Situations of this nature compel competent legal advice. Get advice before you act. Contact the offices of Guelph employment lawyer Peter McSherry. We can help you determine what actions to take when confronting negative covenants.