Non-competition clause in employment agreement governed by common law is unenforceable

by Rhonda B. Levy and Barry Kuretzky of Littler

In M & P Drug Mart Inc. v. Norton, 2022 ONCA 398, the Court of Appeal for Ontario (OCA) dismissed an employer’s appeal of an application judge’s decision that a non-competition clause in an employment agreement governed by the common law was unenforceable because it was ambiguous and overbroad. 

Background

In September 2020, the employee, a pharmacist (Employee), resigned from his employment as pharmacy manager with the employer, a pharmacy (Employer).  The Employee then went to work as a pharmacist at another pharmacy less than three kilometres from the Employer.  The Employee’s employment agreement (Agreement) with the Employer, entered into in 2014, contained a non-competition clause that provided:

The Employee agrees that during the Employee’s employment with the Company and during the one year period following the termination of the Employee’s employment with the Company, for any reason whatsoever, the Employee shall not carry on, or be engaged in, concerned with, or interested in, directly or indirectly, any undertaking involving any business the same as, similar to or competitive with the business within a fifteen (15) kilometre radius of the business located at 10 Main Street East, Huntsville, Ontario P1H 2C9.

The Agreement also contained an acknowledgement from the Employee that the non-competition clause (and a non-solicitation clause also in the Agreement) were necessary for the protection of the Employer’s legitimate business interests and were “reasonable in the circumstances.”

Upon learning about the Employee’s new employment, the Employer reminded the Employee of the non-competition clause through its counsel.  When the Employee’s counsel responded that the non-competition clause was unenforceable, the Employer brought an action alleging that the Employee’s employment with the other pharmacy constituted a breach of the non-competition clause because the Employee went to work at the other pharmacy before the end of its one-year term.

Working for Workers Act, 2021

The Working for Workers Act, 2021 (Act) came into force on December 2, 2021, after the Employee ended his employment with the Employer.  As we have noted, the Act amended the Employment Standards Act, 2000 to prohibit employers and prospective employers from entering into an employment contract or other agreement with an employee or an applicant for employment that is, or that includes, a non-compete agreement, except upon the sale of a business or if the employee is an “executive.”  While the Act provides that the prohibition against non-compete agreements is deemed to be in force effective October 25, 2021, it does not indicate whether the prohibition applies to non-compete clauses entered into prior to the prohibition’s effective date of October 25, 2021. This question was answered, however, when the Ontario Superior Court of Justice held in Parekh et al v. Schecter, 2022 ONSC 302, that the prohibition in the Act against non-compete agreements does not apply to those entered into prior to the prohibition’s effective date of October 25, 2021.

Non-competition agreements entered into prior to that date, such as the one entered into by the parties in M & P Drug Mart, may be enforceable in accordance with the common law, but on an exceptional basis and only if the employer can establish that the non-competition restriction is reasonable as between the parties.

Application Decision

The application judge applied the common law, which governed the parties’ rights and provides that even a non-competition agreement entered into freely is unenforceable, unless it is reasonable as between the parties and with respect to the public interest.  The application judge dismissed the application when he found the non-competition clause unenforceable.  He concluded that the non-competition clause was unreasonable between the parties because it was ambiguous or because the scope of the prohibited activities was overly broad. In arriving at this conclusion, the application judge observed:

• A clause that prohibited “working as a pharmacist at a pharmacy” would have been reasonable;
• The clause was ambiguous, however, because it prohibited the Employee from being “concerned,” even “indirectly,” with and “undertaking involving a business” that was “similar” to the Employer, e.g., a non-pharmacist role in a non-pharmacy department of a supermarket if the supermarket included a pharmacy;
• It was unclear whether the prohibited competition included only businesses that dispensed prescriptions, or extended to any business that sold over-the-counter drugs, cosmetics, greeting cards, food, shaving items, or other products sold by the Employer but also by convenience, grocery, and big box stores; and
• The non-competition clause was overly broad because it prevented the Employee from having an interest in such businesses and from doing work unrelated to the practice of pharmacy, and these restrictions were wider than reasonably required to provide adequate protection to the Employer’s legitimate proprietary interests.

Because the application judge found the non-competition clause was not reasonable between the parties, he did not address whether it was reasonable with respect to the public interest.

OCA Decision

The Employer appealed the application judge’s decision.  The OCA dismissed the appeal when it disagreed with the Employer’s argument that the application judge erred when he concluded that the clause was unenforceable because it was not reasonable as between the parties.

In its decision, the OCA noted that since the employee’s resignation and re-employment occurred prior to the Act coming into force in December 2021, the prohibition on non-competition agreements in employment agreements in the Act did not apply, and the parties’ rights were governed by the common law.

Furthermore, the OCA rejected the Employee’s argument that the appeal was moot because the term of the non-competition clause expired in September 2021.  The OCA found that if the non-competition clause was found to have been valid between September 2020 to September 2021, its expiry would not absolve the Employee of liability for damages for a breach that occurred during that one-year period.

The OCA then analyzed the non-competition clause in accordance with applicable common law principles.  The court agreed with the application judge that the clause was unreasonable because its wording went further than clearly and only restricting the Employee from acting as a pharmacist and, therefore, it was overbroad.  The OCA found that the Employer sought to read the non-competition clause as though such restrictions were not imposed when it insisted on a meaning that ignored the words used.  Furthermore, the OCA rejected the Employer’s attempt to argue that pre-contractual negotiations showed the parties were concerned about the Employee going to work as a pharmacist at another pharmacy, when it stated:

The factual matrix cannot be used to overwhelm or deviate from the contractual text, change the meaning of the words used, nor to effectively create a new agreement….And the court is not empowered to rewrite the covenant “to reflect its own view of what the parties’ consensus ad item might have been or what the court thinks is reasonable in the circumstances.”

Bottom Line for Employers

The decision of the OCA in M & P Drug Mart provides insight into the type of analysis an Ontario court will undertake to determine whether a non-competition clause is enforceable in circumstances where common law principles apply.  The decision suggests that even when an agreement is entered into freely, Ontario courts will determine that a non-competition clause is unenforceable if it is unreasonable between the parties because it is ambiguous or because the scope of the prohibited activities is overly broad.

Such a clause will be more likely to be considered reasonable and enforceable if it clearly and only restricts the employee from engaging in a particular type of work at a specific type of location; however, the clause’s enforceability will be in jeopardy if it goes further, as a court will likely view the prohibited activities as overbroad. Finally, in deciding whether a non-competition clause is enforceable, courts will focus exclusively on the clause’s wording and reject an employer’s efforts to persuade it that certain facts prove the parties’ intention was different from what the contract reveals.