KRG Insurance Brokers (Western) Inc. v. Shafron:
Supreme Court of Canada Rules on Restrictive Covenants and Notional Severance
January 26, 2009
On Friday, January 23, 2009, the Supreme Court of Canada issued its decision in KRG Insurance Brokers (Western) Inc. v. Shafron. Counsel for employers had been anticipating the results of this appeal of an earlier decision of the British Columbia Court of Appeal. The Supreme Court’s decision is important because it reiterates the hallmarks considered by a court in determining whether a particular type of clause, called a restrictive covenant, is enforceable by an employer against an employee.
A restrictive covenant is a type of clause that may be included in an employment contract seeking to limit the ability of an employee to solicit the employer’s other employees or customers following the termination of the employment relationship. A restrictive covenant may extend as far as to attempt to prohibit an employee from competing with the former employer for a certain period of time.
The KRG Case
In 1987, Mr. Shafron joined KRG Insurance Brokers Inc. (KRG) through a sale of his insurance agency. Mr. Shafron was subject to a restrictive covenant that prevented him from competing with KRG within the "Metropolitan City of Vancouver" for a period of three years following the termination of his employment. In 2001, Mr. Shafron left KRG to join an insurance broker practising in the neighbouring suburb of Richmond. A significant number of customers moved their business with Mr. Shafron to his new employer. KRG sued Mr. Shafron to enforce the restrictive covenant prohibiting competition.
Mr. Shafron retained legal counsel and challenged the enforceability of the non-compete clause on the basis that the "Metropolitan City of Vancouver" was not "a recognized location." Although Mr. Shafron was initially successful in challenging the enforceability of the clause, the British Columbia Court of Appeal overturned that decision and ruled in favour of KRG. According to the Court of Appeal, the reference to the "Metropolitan City of Vancouver" should be construed as "the City of Vancouver and the municipalities directly neighbouring it."
The Supreme Court of Canada
Mr. Shafron appealed the decision of the Court of Appeal to the Supreme Court of Canada. Although the end result is an unhappy one for employers, the decision of the Supreme Court is helpful in providing guidance as to what factors will be considered in determining whether a restrictive covenant will be enforceable.
Restrictive covenants are a restraint of trade that courts have always been very cautious to apply. In order for an employer to be permitted to hold a former employee to a restrictive covenant, the clause must be reasonable and unambiguous. In particular, the clause must be reasonable in respect to three primary factors:
- The clause must have a reasonable geographical scope.
- The clause must have a reasonable time limit.
- The clause must be reasonable in the activities it seeks to restrict.
The primary issue in the KRG case was the ambiguity attached to the term the "Metropolitan City of Vancouver." The Supreme Court has made it very clear that an ambiguous clause cannot be a reasonable clause, and will not be enforceable. The British Columbia Court of Appeal applied a legal doctrine known as "notional severance" in order to give meaning to an ambiguous phrase. The Supreme Court of Canada recognized that the Court of Appeal was following a practice of "fixing" an otherwise defective contractual provision to make it legal and enforceable, and determined that this practice was not appropriate in the employment context.
The Supreme Court of Canada’s decision is not helpful to employers who are seeking to enforce restrictive covenants, as it is very clear that the concept of "notional severance" will not be applicable to restrictive covenants in employment contracts. In the words of Canada’s top court:
Employers should not be invited to draft overly broad restrictive covenants with the prospect that the court will sever the unreasonable parts or read down the covenant to what the courts consider reasonable. This would change the risks assumed by the parties and inappropriately increase the risk that an employee will be forced to abide by an unreasonable covenant.
Although the Supreme Court indicated that there may be cases where a "blue pencil" can be used to strike out (i.e., completely remove) a problematic portion of a clause, this will be done sparingly and only in a situation where the portion being removed is clearly trivial and not part of the main purpose of the restrictive covenant.
Lessons for Employers
The decision in KRG marks a reinforcement of the courts’ traditional approach to restrictive covenants. These types of clauses will only be enforceable where they are very carefully tailored to the needs of the employer and do not attempt to extend past the protection reasonably required by the employer.
These clauses must be very carefully drafted as they will be closely scrutinized by the court. Employers can not expect a court to assist them by fixing any defects that might reside in such clauses. Particular attention must be paid to crafting an unambiguous clause that contains reasonable direction regarding its geographic and temporal scope, as well as no more than a reasonable restriction on the type of activity that will be prohibited. Where an employer is seeking to include a non-competition clause into an employment contract, they will also want to include a non-solicitation clause, as discussed at the top of this update.
Please contact any of the lawyers in our national Labour and Employment Group if you wish to discuss this case further or to discuss restrictive covenants in general.