Ontario Employer’s Novel Strategy to Bolster Non-Compete Enforceability Unsuccessful
Love it or hate it, non-competition agreements in Ontario employment relationships are largely unenforceable except in special and limited circumstances. This is on account of restrictions under the Employment Standards Act, and the common law. And yet traditionally, non-competition clauses in shareholders agreements are generally enforceable, subject of course to being reasonable. It makes sense. As part owner of a company, a shareholder should not be allowed to enter into a competitive venture.
In the face of ever-increasing legal limitations on Ontario employers’ ability to protect their legitimate business interests, some employers have crafted unique strategies in an effort to overcome these limitations. These strategies are not always successful, as is illustrated by a recent decision of the Ontario Superior Court of Justice (“ONSC”).
In Wyse Meter Solutions Inc. v. Louie Papanicolopoulos [Wyse], the ONSC held that a non-competition clause in a shareholder agreement which an employer was seeking to enforce against a former employee should be interpreted in the same stringent manner as one contained in an employment agreement, despite that non-competes in shareholder agreements and other commercial contracts are typically subjected to much less scrutiny by the courts. This is because the employer required the employee to purchase shares in the company as a condition of his employment, such that the employee became subject to the non-compete by virtue of their employment.
Background
Ontario employers have long faced challenges in protecting their legitimate business interests due to common law limitations on their ability to enforce restrictive covenants, such as non-solicitation and non-competition clauses.
Notably, it is settled law in Ontario that non-competition clauses are presumptively unenforceable in the employment context, and that they will only be legally enforceable against employees in exceptional circumstances, where the employer cannot adequately protect their legitimate business interests via less stringent restrictive covenants. Less stringent restrictive covenants include non-solicitation clauses and agreements prohibiting employees from misusing the employer’s confidential information. Moreover, even where a non-compete is reasonably required, it will still be legally unenforceable unless it is drafted very narrowly in terms of the scope of the competitive activities it prohibits, the length of time it lasts, and the geographical area to which it applies.
On the other hand, non-competition agreements are far more likely to be legally enforceable in the commercial context, relative to the employment context. For example, the courts recognize that the purchaser of a business will generally require a non-competition agreement with the seller of the business in order to ensure that the goodwill in the business they are purchasing is not undermined by the seller immediately competing with them after the sale.
Furthermore, the situation has become even more challenging for Ontario employers since 2021, when the Ontario government amended the Employment Standards Act, 2000 (“ESA”) to prohibit employers from including non-compete clauses in employment contracts (with limited exceptions), and to make such non-competes void.
The Wyse Decision
The employee in Wyse was employed for two and a half years as the Vice President of Sales and Marketing for Wyse Meter Solutions Inc. (“WMS”), until he resigned to work for a competitor. Notably, the employee was subject to restrictive covenants in both his employment contract and under a shareholder agreement, and he entered into the employment contract prior to the ESA prohibition on non-competes coming into force in December 2021.
Crucially, the employee became subject to the shareholder agreement after purchasing shares in WMS because he was required to purchase these shares as a condition of his employment. The non-compete in the shareholder agreement prohibited the employee from being involved “in any manner whatsoever” in any business competitive with WMS anywhere in Canada while he was a shareholder and for 12 months afterwards. This was despite the fact that the employee owned less than 0.01% of WMS’s issued shares. Moreover, WMS refused to repurchase the employee’s shares, and he was effectively unable to sell the shares to anyone else under the terms of the shareholder agreement. Accordingly, the non-compete under the shareholder agreement was effectively of indefinite duration.
Upon the employee resigning, WMS accessed his company devices and accounts, and it determined that he had accessed certain computer files for no legitimate reason shortly before his resignation. Moreover, the employee later admitted that he had accessed and photographed certain files containing WMS’s sensitive information prior to his resignation, that he should not have taken these photos, and that he had been planning on potentially using this information at his new job. However, he claimed that he later deleted the photographs and that he never used WMS’s confidential information at his new job.
In response, WMS sought an injunction restraining the employee from continuing his employment with his new employer, in addition to an order restraining him from allegedly continuing to misuse WMS’s confidential information in his new employment. In doing so, WMS argued that the non-compete in the shareholder agreement took precedence over the one in the employee’s employment contract, that the shareholder agreement is a commercial contract, and that it should therefore scrutinized less rigorously than a non-compete in an employment contract. WMS presumably took this position to maximize the chances of the non-compete being enforced, given that non-competes in employment contracts are presumptively unenforceable.
The ONSC declined to grant WMS an injunction, and it held that the non-compete in the shareholder agreement needed to be subjected to the same rigorous scrutiny as if it were contained in an employment contract. This is because the court found that the employee became subject to the non-compete by virtue of his employment, given that he was required to purchase shares in WMS as a condition of his employment. As a result, the court found that WMS had not established a strong prima facie case, it refused to grant an injunction, and it dismissed WMS’s application.
Implications
Notably, Wyse only dealt with the employer’s application for an injunction to restrain the former employee from competing against it, such that the court did not make a final ruling on whether the non-compete was legally enforceable. Nonetheless, the ONSC effectively ruled that an employer cannot make a non-compete more likely to be enforceable against a former employee by requiring their employees to buy shares in their company and including the non-compete in a shareholder agreement, rather than including it in an employment contract.
Moreover, although the employee in Wyse entered into his contract prior to the ESA prohibition against including non-compete clauses in employment contracts, this decision also strongly establishes that Ontario employers cannot circumvent this prohibition by requiring employees to purchase nominal shares under a shareholder agreement containing a non-compete clause.
The Bottom Line
Legitimate company interests need good protection from former employees joining competitors. Carefully consider the language of restrictive covenants in any employment agreement applicable to critical customer-facing employees or other employees who by the nature of their position, business goodwill may attach. Make sure the language and its restrictions are not overly broad either in length or geographic scope. Protect what is minimally necessary. Don’t rely upon old contracts, which may now be unenforceable. Update your contracts regularly, whenever there is a change in position or significant increase in pay.
If you require assistance with protecting your company’s legitimate business interests to the greatest extent possible, please do not hesitate to contact us for expert legal advice.
HYDE HR LAW