Wrongful dismissal weakens restrictive covenants, Canadian HR Reporter (September 26, 2011)

04 Sep Wrongful dismissal weakens restrictive covenants, Canadian HR Reporter (September 26, 2011)

WRONGFUL DISMISSAL WEAKENS RESTRICTIVE COVENANTS
By Nikolay Y. Chsherbinin

In an era of high employee mobility, employers frequently attempt to safeguard business interests by contractually preventing employees from competing, soliciting or using confidential information once they leave. Typically, this is achieved through restrictive covenants, such as non-competition or non-solicitation clauses. But, historically, judges have been hostile towards the enforcement of restrictive covenants, correlating them with invalid restraints of trade.

The judicial trend towards a discriminatory enforcement of restrictive covenants — rooted in sensitivity to employer-employee inequality — continued with a decision by the divided Alberta Court of Appeal in Globex Foreign Exchange Corp. v. Kelcher. This decision had strong dissent and raises important employment law issues, including the effect of wrongful dismissal on the enforceability of restrictive covenants, mitigation to consideration.

Sign or resign

In 2003, David Kelcher, Luciano Oliverio and Mark MacLean joined Globex, a foreign currency exchange company. Their jobs were governed by employment agreements that included non-competition and non-solicitation clauses. While MacLean signed his agreement when he began employment, Oliverio and Kelcher signed several agreements after working there for some time.

In 2005, Globex attempted to impose more rigorous requirements on the employees. MacLean refused the new terms and was dismissed. Kelcher and Oliverio resigned, but Oliverio had signed the new agreement 10 days earlier. All three joined a Globex competitor and Globex sued, alleging damages from loss of clients. The trial judge concluded, since MacLean had been wrongfully dismissed, the clauses were not enforceable against him. He also found Oliverio’s and Kelcher’s agreements were unenforceable because there was no fresh consideration given for them and no implied agreement their employment would be continued if they did sign. The non-competition clauses were also unenforceable because they were wider than necessary to protect Globex business, said the judge.

The majority of the Alberta Court of Appeal scrutinized the non-solicitation clause’s language, which prohibited the employees from “solicit(ing) customers in any manner whatsoever, in any business or activity for any client of Globex with which he/she had dealings.”

Relying on the Ontario Court of Appeal decision in HL Staebler Company Limited v. Allan, the court explained that while Globex had an interest in protecting customers in its foreign exchange business, it did not have any legitimate interest in preventing ex-employees from contacting customers for other business. The term “dealings” was also ambiguous both in meaning and practical application, found the court.

Given that MacLean agreed to the restrictive covenants when he accepted employment, his legal situation was different. Relying on the House of Lords’ decision in General Billposting Co. Ltd. v. Atkinson, the court found once an employer repudiates an employment contract by dismissing an employee without cause or notice, it cannot enforce a restrictive covenant. To find otherwise rewards employers for mistreating employees.

The dissenting judge disagreed, stating a breach of MacLean’s employment contract by failure to give him reasonable notice — or pay in lieu — relieved him from any future obligation to provide his services and entitled him to damages, but it did not entitle him to ignore the other covenants.

The resolution of these polarized views will likely be a cornerstone of Globex’s appeal, if any, to the Supreme Court of Canada.

Continued employment alone does not provide consideration for a new covenant extracted from an employee during the term of employment because the employer is already required to continue the employment until there are grounds for dismissal or reasonable notice of termination is given, concluded the court.

The dissenting judge stated consideration is a threshold issue to the enforcement of contracts, which “should not be applied in a mechanical or artificial way and not be used to undermine the legitimate commercial expectations of the parties.” He equated “commercial” with “employment” expectations, where the latter are unique due to the power imbalance between an employee and an employer demanding non-competition covenants.

Mitigation

The court viewed a duty to mitigate as an additional reason why wrongful dismissal ought to relieve an employee from compliance with covenants that restrict future employability. If a wrongfully terminated employee is prevented from doing similar work because of a restrictive covenant, the ability to mitigate will be severely constrained, said the court.

Contrast that view with the position of the Ontario Court of Appeal in Link v. Venture Steel Inc. where it upheld the existence of a non-competition obligation would not completely relieve a dismissed employee from his legal duty to mitigate. “The existence of obligations contained in a restrictive covenant ought to only be a factor in considering the reasonableness of the dismissed employee’s efforts,” said the trial judge in Link.

TIPS FOR EMPLOYERS

Globex presents a good analysis of factors the courts consider in determining when restrictive covenants are likely to be deemed unenforceable. Employers should always ensure a restrictive covenant:

  1. is timely and properly introduced into the employment relationship
  2. precisely addresses a legitimate business interest
  3. has a termination date
  4. limits geographical scope
  5. defines the types of business activities that are prohibited
  6. identifies with certainty clients that cannot be contacted.

If the employer overreaches a covenant’s scope, inevitably, its goal will be frustrated.

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