Two non-competes six weeks apart, and only one held

The situation

The buyer acquired all the shares of a specialty coatings applicator. The vendor held 65 per cent, ran the technical side and was the reason eleven of the target's largest accounts were its accounts. A co-founder held the other 35 per cent and had been semi-retired for two years.

The share purchase agreement contained a restrictive covenant: 24 months from closing, 150 kilometres from the plant, limited to industrial coatings application. The vendor signed it at closing and started as the buyer's technical director that day.

Six weeks later the buyer's HR team ran him through standard onboarding. He signed the buyer's employment agreement, which carried the buyer's standard restrictive covenant: 36 months, all of Canada, any competing activity. Nobody thought about it. It was paperwork.

The problem

Part XV.1 of the ESA prohibits the covenant outright: “No employer shall enter into an employment contract or other agreement with an employee that is, or that includes, a non-compete agreement”. Subsection (2) supplies the consequence: “For greater certainty, subsection 5 (1) applies and if an employer contravenes subsection (1), the non-compete agreement is void”.

The exception is s.67.2(3), and it is worth reading in full rather than in summary, because the summary loses the sequence: “If there is a sale of a business or a part of a business and, as a part of the sale, the purchaser and seller enter into an agreement that prohibits the seller from engaging in any business, work, occupation, profession, project or other activity that is in competition with the purchaser’s business after the sale and, immediately following the sale, the seller becomes an employee of the purchaser, subsection (1) does not apply with respect to that agreement”.

Two conditions, both required. The covenant must be entered into as a part of the sale. And immediately following the sale, the seller must become an employee of the purchaser.

The SPA covenant satisfies both. It sits in the sale document, it was signed at closing as part of the consideration package, and the vendor became an employee that day.

The onboarding covenant satisfies neither. It was entered into six weeks after the sale, by an employer and an existing employee, in a document whose subject is the job rather than the business. It is not part of the sale in any sense the subsection uses, and the sequence it describes — sale, then employment — had already completed. So s.67.2(1) applied to it and s.67.2(2) voided it.

The numbers

The SPA covenant had five months of its 24 left to run and prohibited competition within 150 kilometres. The new shop was 40 kilometres away. On those terms the injunction application was straightforward: $46,000 in fees, heard on an expedited basis.

Those five months were used to move nine of the eleven accounts onto the buyer's own technical lead. Two went with the vendor when the covenant expired, carrying $410,000 of annual revenue. The buyer's own view was that without the five months it would have lost seven or eight.

The rule that decided it

The unit question is which agreement the covenant is in, and when it was entered into. The subsection is not about who signed or what the covenant says; it is about the transaction the covenant is part of and the sequence of events around it. A buyer that puts a modest covenant in the sale document and a generous one in the employment agreement has protected the modest one and destroyed the generous one, which is the opposite of what it intended.

Three corollaries follow from the same wording, and two of them cut against the loose reading of this section.

First, a seller who joins after an interval is outside the exception, because the sequence requires him to become an employee immediately following the sale. A vendor who takes three months off before starting has broken the condition.

Second — and this is where files commonly go wrong — being outside the exception is only fatal if you are inside the prohibition. The co-founder took an eighteen-month consulting agreement rather than employment. Section 67.2(1) prohibits an employer entering into an agreement with an employee, and s.67.1 defines the term for this Part as one that “means an employee as defined in subsection 1 (1) and includes an applicant for employment”. A consultant who never becomes an employee or an applicant for employment is not caught by the prohibition at all, so his SPA covenant does not need the exception and is tested only on ordinary common-law reasonableness. Outside the exception and outside the prohibition are different places.

Third, s.67.2(4) removes executives from the prohibition entirely: “Subsection (1) does not apply with respect to an employee who is an executive”. Subsection (5) defines the term by listing offices — chief executive officer, president, chief administrative officer, chief operating officer, chief financial officer and others — “or holds any other chief executive position”. Two retained managers here were appointed to divisional versions of those offices, and whether a divisional office holder holds the office of chief operating officer on this wording is not settled by the text. The buyer did not rely on it and this file does not resolve it.

A note on what s.67.2(3) does not say. It contains no words limiting it to a business operated as a sole proprietorship or a partnership. Those words appear in the Ontario government's guide to the Act; they are not in the subsection, and a covenant should not be written or abandoned on the strength of them.

The outcome

The injunction issued on the SPA covenant; the employment-agreement covenant was abandoned before the hearing. The buyer’s playbook changed afterwards, and the change was free: vendor covenants now go into the sale document, signed at closing, with the employment offer accepted the same day.

For a covenant that failed on a different axis entirely, see a non-compete unenforceable across two provinces and the non-competition covenant glossary entry.

What it would have cost otherwise

The buyer's standard playbook on every other deal put the covenant only in the employment agreement, on the reasoning that the employment relationship was where the risk lived. Run on this file, that playbook would have produced one covenant, void under s.67.2(2), and no injunction — and eleven accounts worth $2,340,000 with nothing standing between them and a competing shop 40 kilometres away.

The tell

The tell is two covenants of different lengths with the same person in the same deal file. One of them is redundant. The redundant one is almost always the longer one, and the longer one is almost always the one counsel will reach for, which is how a drafting convenience becomes the whole case.

Takeaways

• • Section 67.2(3) has two conditions and a sequence: the covenant must be entered into as a part of the sale, and the seller must become an employee immediately following the sale. Missing either takes the covenant back under the prohibition.
• • Put the vendor's covenant in the purchase agreement, signed at closing, and accept the employment offer the same day. A covenant added at onboarding six weeks later is a different agreement with a different fate.
• • Being outside the exception is only fatal if you are inside the prohibition. A vendor who becomes a consultant rather than an employee is outside both, and his covenant is tested at common law.
• • Section 67.2(3) does not limit the exception to sole proprietorships or partnerships. Those words come from the government's guide, not the Act.

Sources

• • Employment Standards Act, 2000, S.O. 2000, c. 41 (Ontario) — s.67.1 definitions of employee and employer for Part XV.1; s.67.2(1) prohibition; s.67.2(2) voidness; s.67.2(3) the sale exception, quoted in full above; s.67.2(4) and s.67.2(5) the executive exception and its list of offices.
• • Treadstone Law — why sale-of-business non-competes are enforceable in Ontario — on point for why sale-of-business covenants are treated differently from employment covenants in Ontario. It does not work through the drafting sequence in s.67.2(3), which is what decided this file.
• • Treadstone Law — personal versus corporate non-competes on an Ontario business sale — background on where a covenant sits and who gives it.