Ontario CA case highlights enforceability of non-compete clauses in M&A, says lawyer

While non-compete clauses are unpopular and presumptively unenforceable in employment contracts, a recent Ontario Court of Appeal ruling serves as a helpful reminder of their enforceability in M&A deals, says Charlie Kim, a partner at Robins Appleby LLP.

According to a January Angus Reid poll, over half of Canadians support banning the clauses in employment contracts. A non-compete clause prohibits an employee from working with a competitor following the cessation of their employment. Ontario banned them from employment contracts, with certain exceptions, in 2021.

In April, the US Federal Trade Commission approved regulations largely prohibiting non-compete agreements in the employment realm. Kim, who practises in the firm’s business and transactions group, says this prohibition mirrors the law in Ontario.

“It's important to distinguish a non-competition clause within the context of employment agreement versus the context of an M&A transaction,” he says.

In an employment agreement, the courts will generally view a non-compete clause as illegal and unenforceable, says Kim, unless it is “reasonable and necessary” to protect a justifiable position of the employer. But, in an M&A transaction, courts generally prefer not to intervene.

“They take the reverse presumption in a commercial context. The restrictive covenant is deemed to be lawful unless it can be shown to be unreasonable.”

Kim says Dr. C. Sims Dentistry Professional Corporation v. Cooke, 2024 ONCA 388 illustrates the point. In this case, Sims purchased Cooke’s Hamilton, Ont.-based dentistry practice. Cooke agreed to work for Sims as an associate for at least two years and not to practise dentistry or allow his name to be used in another dentistry practice within a 15 km radius of Sims’ clinic for five years.  

Sims terminated Cooke two years after the sale. Cooke then joined a dental practice 3.3 km away from Sims’ clinic, taking the position that the non-competition covenant was unenforceable.

After losing his argument at trial, Cooke told the Court of Appeal that the trial judge had incorrectly reversed the burden of proof. To be lawful, he said the party seeking enforcement of a non-compete agreement must prove it is reasonable.

In her ruling, Justice Katherine van Rensburg referred to what her court had said in a prior decision: “Courts will give more scrutiny to the reasonableness of a restrictive covenant in the employment context while applying a presumption of validity to such clauses where they have been negotiated as part of the sale of a business.”

van Rensburg also pointed to Elsley, Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6, in which Canada’s highest court recognized that the rules applying to restrictive covenants in employment contracts differ depending on whether they are linked to the contract of employment or the sale of the business. This is partly because parties negotiating the sale of assets have more freedom of contract than parties negotiating a contract of employment. This follows from the reality that parties to a commercial agreement for the sale of a business are best positioned to decide what is reasonably required to protect the purchaser’s interests, said van Rensburg.

The judge went on to say that Cooke and Sims were both represented by legal counsel and had equal bargaining power. “[W]here the parties’ agreement is the best and most reliable expression of their joint intention, it made sense to treat the Non-competition Covenant as presumptively legal.”

“The court ultimately reaffirmed the law that in the context of an M&A transaction, the courts would generally not intervene to invalidate a noncompetition covenant,” says Kim.

The takeaway, he says, is that a seller of a business should not view a restrictive covenant agreement as an “ancillary aspect” of the deal. “It is absolutely fundamental to a purchase-sale transaction.”