Breaking The Blunt Arrow: Bill 27's Ban on Non-Compete Agreements

By Martin Smith and Desneiges Mitchell

First presented at the LSO's 2022 Annotated Employment Agreement Seminar

1. What was the legal landscape prior to the amendments to the Employment Standards Act, 2000?

A non-competition clause is a type of restrictive covenant. It typically purports to preclude an employee from engaging in work that competes with its former employer's business for a period of time after the employment relationship ends. In the well-known Court of Appeal decision Lyons v. Multari,¹ non-competition clauses were described as a "drastic weapon in an employer's arsenal."² If non-competition clauses are indeed a weapon, the common law served as an effective shield.

Prior to the recent amendments to the Employment Standards Act, 2000 ("ESA"), non-competition clauses were already extremely difficult to enforce. The body of case law considering non-competition clauses in a regular employment law context is replete with criticisms and rejections. The courts have held that only in "exceptional cases" does the nature of an employment relationship justify a non-competition agreement.³

...the law is loath to place restrictions on an employee's ability to compete with their former employer...

Generally, the law is loath to place restrictions on an employee's ability to compete with their former employer, often described as a "restraint of trade." Given the imbalance of power between an employer and employee, courts recognize that an employee's ability to negotiate the terms of an employment contract is limited. In addition, the public interest is typically not served by restricting competition.

Before the amendments to the ESA, in order to enforce a non-competition clause, an employer had to prove that:

the non-competition clause was reasonably necessary for the protection of the employer's legitimate business interests;
the non-competition clause is "reasonable" in terms of:
- duration;
- geographical location;
- nature of the activities prohibited;
- fairness to both parties
the terms are clear and certain;
the clause is not otherwise contrary to the public interest.⁴

Courts frequently determine that non-competition clauses are vague, ambiguous, overbroad, and/or contrary to the public interest.

In an effort to enhance the likelihood that these clauses are enforced and injunctions granted, additional clauses have often been added whereby the employee agrees that the limit on competition is reasonable and/or that the employer will be irreparably harmed by a breach. Employment contracts also often state that the employee agrees to an interim injunction and/or damages resulting from any breach.

Courts have rejected these attempts to buttress non-competition clauses. As explained in a recent Superior Court decision:

"[i]f a covenant is unreasonable based on appropriate legal standards, a provision in the agreement that deems it to be reasonable is legally ineffective. Similarly, if the plaintiff cannot demonstrate irreparable harm, the agreement cannot deem the plaintiff to have done so."⁵

...employment contracts often contain clauses that attempt to narrow unreasonable non-competition clauses to avoid invalidation.

In addition, employment contracts often contain clauses that attempt to narrow unreasonable non-competition clauses to avoid invalidation. The courts have also rejected this approach:

"if the covenant is defective, it cannot be saved by severance or by otherwise rewriting the clause and it must be struck down in its entirety."⁶

Employers are often surprised to learn that their non-competition clauses are not likely to be enforced. The new amendments to the ESA remove any doubt in most cases.

2. What are the new amendments to the ESA?

The Working For Workers Act, 2021⁷ ("WWA") was introduced on October 25, 2021. It received royal assent on December 2, 2021. It amended the ESA to, inter alia, prohibit employers from entering into an employment contract (or other agreement) with an employee (including an applicant for employment)⁸ that is, or includes, a non-compete agreement.⁹

The Act defines a "non-compete agreement" as:

"an agreement, or any part of an agreement, between an employer and an employee that prohibits the employee from engaging in any business, work, occupation, profession, project or other activity that is in competition with the employer's business after the employment relationship between the employee and the employer ends."¹⁰

The prohibition against non-compete agreements was deemed to be in force effective October 25, 2021.

3. What are the exceptions?

There are two important exceptions to the new statutory prohibition on non-competition agreements.

The first exception is where there is a sale of a business (or part of a business), and as a part of the sale, the purchaser and seller enter into an agreement that prohibits the seller from engaging in any business (or work, occupation, profession, project or other activity) that is in competition with the purchaser's business after the sale and, immediately following the sale, the seller becomes an employee of the purchaser.¹¹ In those cases, the prohibition does not apply. In this section of the ESA, "sale" includes a lease.¹²

...a purchaser wisely enters into an agreement to ensure that the seller cannot start a new business to serve its customers.

This statutory exception reflects the existing state of the law. Non-competition clauses in agreements where a seller becomes employed by a purchaser are more frequently upheld. Indeed, the Supreme Court of Canada has distinguished between non-competition clauses negotiated as part of the sale of a business and non-competition clauses that are part of an employment contract.¹³ The justification for this distinction is that part of the value of a business is its goodwill. In order to protect its investment, a purchaser wisely enters into an agreement to ensure that the seller cannot start a new business to serve its customers.

The second exception is that the new prohibition is that it does not apply with respect to an employee who is an "executive."¹⁴ The ESA defines "executive" as

"any person who holds the office of chief executive officer, president, chief administrative officer, chief operating officer, chief financial officer, chief information officer, chief legal officer, chief human resources officer or chief corporate development officer, or holds any other chief executive position."¹⁵

Of course, this does not mean that non-competition clauses with executives or vendors of a business are automatically enforceable, but simply that they are not prohibited by the ESA. The use of these clauses in these permitted contexts should still comply with the above-noted law.

What about contracts drafted prior to October 25, 2021?

We are fortunate to already have a decision that considers non-competition clauses entered into prior to October 25, 2021. In Parekh et al v. Schecter et al.,¹⁶ the plaintiffs brought an interlocutory injunction motion seeking an order to enforce a non-competition clause between a dentist and a dental practice.

In Parekh, one of the terms of the Share Purchase Agreement was that the dentists would enter into Associate Agreements upon closing. The Associate Agreement contained restrictive covenants including a non-competition agreement that restricted the defendant from practicing within a 5 km radius.

The respondent dentist argued that the legislation applied retroactively by necessary implication and that the non-compete clause was void. He argued that if it did not apply retroactively, there would be a lack of legal uniformity and create two tiers of employees.

Justice Sharma disagreed and explained that:

"new legislation that affects substantive rights will be presumed to have only prospective effect unless it is possible to discern a clear legislative intent that it is to apply retrospectively."¹⁷

In this case, the intention of the legislature was clear. Section 34(3) of the WWA states that the non-compete clauses are "deemed to have come into force on October 25, 2021."¹⁸ Given the express legislative intent to make the amendments applicable as of October 25, 2021, and not earlier, "it cannot be said the provisions with respect to the non-compete clause appy to contracts of employment with non-compete clauses entered into before October 25, 2021."¹⁹

Justice Sharma noted that "[a]t most, and in respect of this case, the new ESA provisions confirm the public policy against restraint of trade, which has already been accepted in the common law."²⁰

4. What if clients are still using precedents with non-competition clauses for contracts entered into after October 25, 2021?

...employers would add non-competition clauses (hoping) employees would believe that they were enforceable...

Prior to Bill 27, employers would add non-competition clauses either not knowing that they were unlikely to be enforced or despite knowing that they were not likely to be enforced. Because there was a possibility that employees would believe that they were enforceable or because there was a risk (albeit often small) that they could be enforced under the common law test, there was still reason to include them in employment contracts. In Ontario, that strategy is no longer wise.

In the now well-known case Waksdale v. Swegon North America Inc.,²¹ the Ontario Court of Appeal affirmed that the "without cause" provision could not be applied to define the employee's entitlements upon termination because the "with cause" provision in the same employment contract was unenforceable. The Court also refused to give effect to the severability clause in the employment contract.

Now that non-competition clauses are contrary to the ESA (subject to the above-noted exceptions), it is reasonable to wonder what would happen if one was included anyway.

It can be argued that invalidating a termination provision based on the inclusion of an unenforceable non-competition clause is unreasonable. In Waksdale, the court was dealing with two termination provisions. A non-compete is its own separate clause with respect to a separate issue and many would argue that it should not serve to invalidate an otherwise valid termination clause.

However, a termination clause and a non-competition clause are not dissimilar in that they both deal with what happens upon the termination of the employment relationship. Moreover, when the actual reasoning from Waksdale is reviewed, there is in fact risk in continuing to insert non-competition clauses which run contrary to the ESA.

In Waksdale, the Court of Appeal noted, inter alia:

the ESA is remedial legislation, intended to protect the interests of employees.²²
an employment agreement must be interpreted as a whole and not on a piecemeal basis.²³
in conducting the analysis, it is irrelevant whether the termination provisions are found in one place in the agreement or separated, or whether the provisions are by their terms otherwise linked;²⁴
it is irrelevant that the employer was not pursuing a "for cause" dismissal and was not seeking to rely on the impugned provision.²⁵

When considering the Court of Appeal's analysis, it is certainly possible to conceptualize a non-competition clause invalidating a termination clause. The Court of Appeal was clear that "non-reliance on the illegal provision is irrelevant" to the analysis.

The Court of Appeal also quoted Machtinger v. HOJ Industries Ltd.²⁶ stating that:

"if the only consequence employers suffer for drafting a termination clause that fails to comply with the ESA is an order that they comply, then they will have little or no incentive to draft a lawful termination clause at the beginning of the employment relationship."²⁷

Therefore, it is reasonable to argue that the consequence of drafting a non-competition clause should be the invalidation of other clauses so that employers have an incentive to draft lawful clauses at the beginning of the employment relationship.

5. Are there any creative solutions for employers who want to restrict competition?

The ESA amendments prohibit the use of agreements that include non-competition provisions. A non-competition agreement is an agreement that "prohibits" the employee from engaging in work that is in competition with the employer's business.

... efforts to disincentivize competition will also not likely be upheld.

What about clauses that do not prohibit competition but rather disincentivize it? For the same reasons that underlie the common law's aversion to non-competition agreements, efforts to disincentivize competition will also not likely be upheld. The "restraint of trade" doctrine could be applied to a clause that does not directly prohibit competition.

However, an interesting case for consideration is Rhebergen v. Creston Veterinary Clinic.²⁸ In that case, the British Columbia Court of Appeal considered an appeal regarding a non-competition agreement that did not prohibit competition but rather created a disincentive.

Specifically, a veterinarian was required to pay her employer a specific amount if, within three years of the end of her employment, she set up a practice within a 25-mile radius of her employer's clinic. The amount varied between $90,000 and $150,000 depending on when the practice was set up. The amount was calculated on the cost of investing and hiring an associate and the impact on the employer's goodwill.

The trial judge held this was a restraint on trade and was unreasonable and unenforceable based on the ambiguity and nature of the penalty. However, the majority of the Court of Appeal disagreed and allowed the appeal.

The case is very helpful in that it thoroughly canvasses the jurisprudence that will be of interest to employment lawyers in Ontario.

The decision starts with the dissent. However, the entire Court agreed on many principles. The analysis explained that:

"[u]nlike the prohibition that renders a more conventional clause a restraint of trade, a clause in the form of [this clause] may be considered a restraint only because of the financial consequence for which it provides. Here, the clause, which is not prohibitory but permissive, burdens an employee with the cost of pursuing the practice of her profession as she may wish which she would not otherwise bear. Whether such a clause in a contract of employment amounts to a recognized restraint for the purposes of the doctrine, rendering the clause unenforceable if unreasonable, is, in my view, by no means settled law."²⁹

The decision notes that there are two strands of authority when it comes to this type of clause:

the "functional" approach, which asks whether the clause at issue attempts to, or effectively does, restrain trade, in which case it will be captured by the doctrine and subjected to reasonableness scrutiny; and
the "formalist" approach, in which the clause must be structured as a prohibition against the competition to constitute a "restraint".

The majority and dissent all agreed that:

the functionalist approach should be used;
the agreement was a prima facie restraint of trade;
the payment was not a "penalty"; and
the amount payable was based on a concerted effort to calculate the real cost of her departing and competing.

The Court of Appeal was divided on whether or not the clause was ambiguous and therefore unreasonable and unenforceable. The majority found that "setting up a veterinary practice" was not ambiguous and allowed the appeal.

A note of caution: this case is highly fact-specific. Notably, neither the majority nor the dissent engaged in an assessment of its overall reasonableness or the public interest (this was a veterinarian trying to practice in a rural area which was arguably in the public interest).

Moreover, in Amma v. Singh,³⁰ the Court undertook a review of the case law in Ontario and took a formalistic approach. It stated that the law in Ontario did not require an investigation into the practical effects of the provision's operation. It will be interesting to see if the new amendments influence this analysis.

Ultimately, it is prudent to err on the side of caution. If attempting to create disincentives to competition in lieu of a prohibition, employers will need to try narrow, reasonable, clear and justifiable clauses.

Lyons v. Multari 50 OR (3d) 526, [2000] O.J. No. 3462
Ibid at para. 31.
Ibid at para 34.
Restrictive Covenants: When the Honeymoon Ends, 2016 CanLIIDocs 61.
Crawford Packaging Inc. v. Dorata, 2020 ONSC 3555 (CanLII) at para. 23.
Ibid at para. 25.
SO 2021 c. 35.
Employment Standards Act, 2000, SO 2000, c. 41 at s. 67.1
Ibid at s. 67.2.
Supra note 8.
Ibid at s. 67.2(3).
Ibid at s. 67.2(5).
Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6.
Supra note 8, s. 67.2(4).
Ibid, s. 67.2(5).
Parekh et al v. Schecter et al, 2022 ONSC 302.
Ibid at para. 45.
Ibid at para. 46.
Ibid at para 47.
Ibid at para. 48.
Waksdale v. Swegon North America Inc, 2020 ONCA 391.
Ibid at para. 7.
Ibid at para. 10.
Ibid at para. 10.
Ibid at para. 11.
Machtinger v. HOJ Industries Ltd, 1992 CanLII 102.
Supra note 21 at para. 7.
Rhebergen v. Creston Veterinary Clinic. 2014 BCCA 97.
Ibid at paras. 25-26.
Amma v. Singh, 2019 ONSC 3989.