PROTECTING COMPANY SECRETS WHEN THEY WALK OUT THE DOOR
Howard Levitt unpacks what makes non-competition clauses enforceable.
Questions relating to employees’ obligations to their employers are among those I am most frequently asked.
Most companies’ main assets have legs. And they often use them to “walk across the street” and join the competition. Given the costs of recruiting, training and familiarizing employees with your clients and systems, it is much less expensive for employers to simply poach valuable employees from other companies than develop those employees themselves.
Employees have duties of faithfulness and honesty to their employers. The law as to whether that obligation of good faith is reciprocal — that is, employer to employee — was argued by me recently at the Supreme Court of Canada in a case called Mathews vs. Ocean Nutrition.
Employees also have a duty to keep company secrets confidential. Employers often make employees sign confidentiality agreements that frequently serve, if not drafted broadly enough, to actually restrict the confidentiality obligations employees have in the absence of a contract.
In other words, if drafted poorly, as they often are, these clauses serve to reduce employees’ confidentiality obligations. The one advantage of such clauses is that they remind employees of this duty.
Confidentiality obligations survive the end of employment and are the most useful tool employers have when suing an employee for competing. Other than confidentiality protections, employers’ protections against predatory former employees are fleeting and relatively minimal.
Respecting most departing employees, employers have no protection at all, other than not to use their confidential information, customer lists, etc. Employers have greater protections respecting key employees, entitled fiduciaries, who the employer has reposed considerable trust and confidence in and is therefore vulnerable to their predations.
Those former employees cannot solicit other employees and, more significantly, customers and business opportunities from their former employers. But there is nothing stopping them from accepting opportunities/ customers that legitimately seek them out.
In the United States, there is a “doctrine of inevitable disclosure”, which states that, if an employee has sufficient information in their heads, they are likely to disclose it to a new employer and, therefore, a former employer can obtain an injunction for a reasonable period to restrain that competition. That is not the law yet in Canada, but its argument can be used to support an otherwise valid non-competition clause.
The only protection employers in Canada have against employees directly competing with them is if they have a properly worded non-competition covenant.
But non-competition covenants are seldom enforced in Canada. They will not be enforced at all unless:
the former employee is a key
■ executive in a position to actually significantly damage them;
the duration of the non-competition
■ covenant is no longer than the time the employer would reasonably need to preserve its goodwill and the information the employee possesses remains current;
it only covers a geographic
■
area in which the employer has a serious legitimate interest in protecting.
If the non-competition clause is longer or broader than the employer requires for its legitimate protection, it will be unenforceable. The court will not rewrite a non-competition contract to make it enforceable and the contract stipulating that the court can do so is also unenforceable. For example, a contract stipulating that the employee cannot compete for 12 months but, if that is unenforceable, for nine months, and if that is unenforceable, for six months, would be unenforceable.
Non-competition contracts are also more likely to be enforceable if the employer had a unique method of operations or a significant investment in the employee’s training so that the employee would be significantly and unfairly damaged if the employee was free to compete with it.
There is also the issue of whether a court will provide an injunction to enforce a valid non-competition clause or only provide damages. The court then looks at the issues of balance of convenience and whether the employer is “irreparably harmed,” which could not be compensated for in damages.
Various U.S. states have banned non-competition covenants entirely, and interestingly, U.S. studies have shown that employees have moved to those states from states where such contracts are strictly enforced. That debate has not significantly developed among Canadian legislators.
Non-competition covenants will also be unenforceable if the court decides that a simple non-solicitation covenant, preventing the employee from soliciting its customers and clients, would provide sufficient protection of the employer’s legitimate needs.
Short of a full non-competition clause, there are also non-solicitation clauses, preventing employees from soliciting former customers, business opportunities and employees, similar to the obligations of fiduciaries. They, too, must be reasonable in geographic area and duration in the same way as non-competition covenants. But, if they are, unlike non-competition clauses, courts will almost always enforce them.
I generally recommend non-solicitation clauses of no more than a year and non-competition clauses of no more than six months, although they can be longer if it genuinely would take longer than that for the employer to be able to preserve its goodwill and secrets from that former employee.
These cases are always decided on a fact-specific basis. It is best if the length, duration, etc. of all of these clauses is customized to the needs of that employer respecting each particular employee. Standard forms with identical terms of duration and area for everyone are less likely to be enforced.
I am often asked by employees and their hiring employers whether a contract is enforceable. Although few of those I see actually are, employees are still at risk whenever they sign a non-competition clause.
Most employers will ask whether the employee has signed such a clause and, even if they conclude it is not enforceable, many will demur before hiring that employee as she or he could be facing potential lengthy litigation even if ultimately successful.
The best case for an employer in restraining competition, even when there is no contract, is if they have evidence that the employee had taken their confidential information, whether while still employed or thereafter.