Economic Disincentives to Compete Found to be Restraints of Trade

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Economic Disincentives to Compete Found to be Restraints of Trade

The B.C. Court of Appeal’ decision last year in Rhebergen v. Creston Veterinary Clinic, 2014 BCCA 97, is both a win and a loss for employers seeking to restrain employees from competing with them post-employment. In both instances, the decision will have long-reaching effects over employer’s strategies to implement effective restraints and the courts’ decisions on enforceability.

In this, the first of two articles, I will review the Rhebergen’s implications for the use of economic disincentives to compete (as opposed to outright prohibitions). Next week, I will review the Court’s approach to addressing whether a restrictive covenant is ambiguous and therefore unenforceable.

The Facts

The Respondents operated a veterinary clinic in the Creston Valley. The primary business consisted of servicing eight dairy farms in the immediate vicinity. There were no other such clinics within B.C. within a 100-mile radius.

The Appellant graduated from veterinary college and obtained her license. In order to gain practical experience, she applied for work at the clinic and entered in to a three-year “Associate Agreement” under which she was paid $65,000 per year.

The agreement set out particular financial consequences should the Appellant set up a competing practice within three years of the termination of the Agreement. The relevant provisions stated:

  1. NON-COMPETITION
  2. The Associate acknowledges and agrees that she will gain knowledge of and a close working relationship with the CVC’s [Creston Veterinary Clinic Ltd.’s] patients and clients which would injure CVC if made available to a competitor or used for competitive purposes.
  3. The Associate covenants and agrees that in consideration of the investment in her training and the transfer of goodwill by CVC, if at the termination of this contract with CVC she sets up a veterinary practice in Creston, BC or within a twenty-five (25) mile radius in British Columbia of CVC’s place of business in Creston, BC, she will pay CVC the following amounts:

If her practice is set up within one (1) year termination of this contract – $150,000.00;

If her practice is set up within two (2) years termination of this contract – $120,000.00;

If her practice is set up within three (3) years termination of this contract – $90,000.00.

* * *

  1. TERMINATION
  2. CVC agrees not to terminate this agreement during the term hereof except for just cause as hereinafter defined.
  3. The Associate cannot terminate this agreement prior to the expiry of the term, except for death, permanent disability preventing the Associate from continuing to practice veterinary medicine, or default of this agreement by the CVC….

The two principals of the clinic calculated the amount to be paid if the Appellant were to set up a practice within 25 miles of Creston based primarily on their experience in hiring a former associate. They took into account the recoverable and unrecoverable investment made in mentoring, training and equipment and the impact on the clinic’s good will and business if she were to compete for its clientele.

Differences arose between the parties and after 14 months Rhebergen advised she was terminating the agreement and would no longer work for it, whereupon the clinic told her she had no right to terminate the agreement and then proceeded to terminate her employment for cause. Five months later, Rhebergen gave notice that she intended to set up a mobile dairy practice and commenced proceedings seeking to have the section requiring a payment to the clinic declared unenforceable.

Economic Disincentives Considered to be a Restraint of Trade

The trial judge, relying on  Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6 (CanLII), held the clause to be in restraint of trade and unenforceable on several grounds.

At the Court of Appeal, the panel first deal with the issue of whether section 11, not being an outright prohibition on competition, was nonetheless a restraint of trade and therefore unenforceable if unreasonable. The Court noted there are two strands of authority as to whether a clause that creates financial consequences arising from competition, but does not outright prohibit competition, is a restraint:

…there appears to be essentially two strands of authority in the employment context: first, what one may call a ‘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 second, a more ‘formalist’ approach, in which the clause must be structured as a prohibition against competition to constitute a ‘restraint’.  On the latter approach, mere disincentives to post-employment competition are not sufficient to trigger the doctrine, even if those disincentives operate as effectively at dissuading competitive conduct and participation in the marketplace as a prohibition.

(at para. 28)

Lowry, J.A.,  after reviewing case law in the U.K.,  B.C. and Ontario, held:

 the functionalist approach established in English law is to be preferred as the legal basis for determining whether clauses that burden employees with financial consequences, whether by payment or forfeiture, they would not otherwise have for engaging in post-employment completion constitute a restraint of trade….it is a matter of the effect of the clause in practice over its form.

(at para. 42)

The Court’s decision to adopt the functionalist approach aligns British Columbia with the reasoning of the Ontario Superior Court in Levinsky v. The Toronto-Dominion Bank2013 ONSC 5657. Clauses that impose financial consequences for competing post-resignation, such as the “claw-back” of exercised stock options, will only be enforceable if they can be said to be reasonable.

By contrast, in an earlier decision of the Ontario Superior Court, Nortel Networks Corp. v Jervis, 2002 CanLII 49617, the departing employee was sued under a “claw-back clause” which required re-payment of market gains from exercised stock options if he went to work for a competitor within 12 months of exercising the options. The Ontario court held that as Jervis “was not precluded from going elsewhere or from doing whatever he chose to do”, the clause was not a restraint of trade.

Going back to Rhebergen, if “permissive” clauses that allow competition but demand a price constitute restraints of trade, how will they be assessed for reasonableness? Lowry J.A., on behalf of the Court, suggests the amount to be paid, or the amount forfeited “may have to be considered as an element of the fairness of a non-competition clause of that kind.”

Should that be the case, employers will need to carefully weigh the amount of money being forfeited or required to be repaid when insisting on financial consequences if a key employee competes after resigning. While the law of penalties has no application to payments upon the occurrence of an event, i.e. competition, extravagant or unconscionable requirements may cause a court to consider such clauses to be nonetheless unfair and hence unenforceable.