Post Employment Competition and Customer Solicitation by David W. Buchanan, Q.C. Clark Wilson LLP tel. 604.687.5700 www.cwilson.com
TABLE OF CONTENTS I. RESTRICTIVE COVENANTS...1 II. THE FIDUCIARY RELATIONSHIP...2 A. What is a fiduciary?...2 B. A Change of Direction...4 C. If a fiduciary relationship is established, is the fiduciary prohibited from any solicitation of customers?...6 D. Is there a cause of action against a new employer?...6 E. Does it matter whether the fiduciary employee was terminated or resigned?...7 F. Does the fiduciary obligation last indefinitely?...7 G. Can a former employee solicit other employees after his departure?...7 H. Remedies...7 I. What is the effect of delay?...8
Post Employment Competition and Customer Solicitation As the world of business has become more technical and complex and as competition has intensified there has been a substantial increase in the number and type of problems related to post employment competition and customer solicitation. In the absence of a restrictive covenant, it was formerly thought that employers had very limited remedies against former employees and the courts generally only afforded protection in circumstances where the employee took with him or her hard copy such as customer lists or confidential documents. Over the past 20 years, however, there have been a number of substantial changes in the protection afforded to employers when faced with unscrupulous former employees who take advantage of confidential information gleaned from their former employment and use it to their own advantage or to the advantage of a new employer and to the detriment of their former employer. The following is a review of these developments, firstly in circumstances where a restrictive covenant is in place and secondly where a restrictive covenant is absent. I. Restrictive Covenants Historically, employers have attempted to give themselves some measure of protection by incorporating restrictive covenants in contracts of purchase and sale of businesses, employment contracts, or shareholder s agreements. Such covenants generally provide that in the event of the termination of the employee s employment, the employee will not compete with the employer for a stipulated period of time over a stipulated geographical area. The first premise is that all covenants in restraint of trade are contrary to public policy and void unless the parties seeking to uphold the restrictive covenant can prove that it falls within one of the recognized exceptions to the general rule. The party attempting to enforce a restrictive covenant has the onus of proving that there is a legitimate interest to protect and that the protection is reasonable. The courts have generally required that there were four questions to be answered in determining whether or not a restrictive covenant should be enforced, namely: 1. Is the subject covenant in restraint of trade? 2. If so, does the employer have a proprietary right or legitimate interest that requires protection?
p. 2 3. If so, is the extent of the protection reasonable in the circumstances of the case; 4. If all the answers are yes, does public interest demand that the covenant not be enforced because it would be contrary to the public interest to do so. In reviewing the reasonableness of a restrictive covenant, the courts generally focus on firstly, its duration, and secondly, the geographic area covered. For example, an employer whose business covers a five-block area, such as a corner store, is not likely to succeed in establishing that a restrictive covenant that prevents a former employee from working in a general store anywhere in Canada for a period of 10 years would be enforceable. The courts are also far less likely to enforce restrictive covenants which arise out of the employment relationship than restrictive covenants that are contained in documents relating to the purchase and sale of a business. Some restrictive covenants fall into different categories again; these might include tied selling arrangements like licensing, dealerships and franchising. While the courts still seem to be prepared to enforce restrictive covenants in connection with the purchase and sale of businesses where the vendor expressly agrees that the restrictions are necessary to protect the business and waives all defences to the strict enforcement of the agreement, the courts tend to afford less protection to employers when trying to enforce such covenants against former employees. The difference in approach appears to be founded in the view that in the employer/employee relationship there is an inequality of bargaining power and the opportunity for oppression, duress, or undue influence to be present. This is particularly so when the employer attempts to extract a restrictive covenant from an employee who is already employed. There is a risk that the court may consider that the employer is suggesting to the employee, explicitly or implicitly, that the signing of the restrictive covenant is a condition of continued employment. It can therefore be seen that restrictive covenants have limited application and have probably become more difficult to enforce than they used to be. A further complicating factor is that most employers wish to enforce restrictive covenants by way of injunction proceedings. An injunction to prevent someone from carrying on business is generally very critically examined by the courts and lack of reasonableness is often the basis on which an injunction is refused. II. The Fiduciary Relationship A. What is a fiduciary? A fiduciary is a person having a duty, created by his undertaking, to act primarily for another s benefit in matters connected with such undertaking. It implies the concept of utmost good faith in the relationship between the fiduciary and the beneficiary. Generally speaking the test of a fiduciary relationship includes the following characteristics: 1. The fiduciary is in a position to exercise some discretion or power;
p. 3 2. The fiduciary can unilaterally exercise that power or discretion so as to affect the beneficiary s legal or practical interest; 3. The beneficiary is peculiarly vulnerable to or at the mercy of the fiduciary holding the discretion or power. It has been clear for many years that some employees, such a directors, or senior officers, owe a fiduciary duty to their employer. Following the landmark Supreme Court of Canada decision in Canadian Aero Services Ltd. v. O Malley 1 in 1974, there was a rapid expansion in the principles governing the classification and obligations of fiduciaries, particularly those relating to employees. In Canaero, as the case is known, the plaintiff carried on a topographical mapping business. The defendants were two long-term senior employees of the plaintiff. Both defendants had extensive involvement in the pursuit by Canaero of a project for the topographical mapping of parts of Guyana to be financed through foreign aid. Up until July 25, 1966, they actively pursued that project on behalf of Canaero but on August 16, 1966 they incorporated their own company, and three days later resigned their positions at Canaero. They then submitted their own proposal to the Canadian Government for the Guyana project and were ultimately successful. The plaintiff s action for breach of fiduciary duty was dismissed both at trial and at appeal but was successful in the Supreme Court of Canada. What was important to the Supreme Court of Canada was that the employees were senior officers of the company, top management rather than mere employees, and as a result the Court held that they were subject to similar duties to those owed to a company by its directors. The Court considered three factors in determining whether or not a fiduciary obligation lay between an employee and employer, namely: 1. The nature of the office held by the employee and the nature of the business opportunity that the employee pursued; 2. The knowledge possessed by the employee and the circumstances under which this knowledge was obtained; 3. The time when the alleged breach of duty occurred and the circumstances of the termination of the employee Those considerations were then expanded by the courts over the next 25 years. For example, it was held in an action in the Ontario Court (General Division) in Sure-Grip Fasteners Ltd. v. Allgrade Bolt & Chain Inc., 2 that fiduciary duties exist where the employer reposes trust and confidence in the employee on a continual basis, relying upon the employee in reaching business decisions. 1 [1974] S.C.R. 592, 40 D.L.R. (3d) 371 2 (1993), 45 C.C.E.L. 276
p. 4 In E.J. Personnel Services Inc. v. Quality Personnel Inc. et al, 3 the Ontario High Court held that Where an employer by the nature of its business is particularly vulnerable to loss by the soliciting of that employer s clients, an employee stands in a fiduciary relationship to the employer and owes a duty to the employer not to solicit those clients after leaving the business. In Guerin v. The Queen, 4 a judgment of the Supreme Court of Canada, the Court held that it is sometimes said that the nature of fiduciary relationships is both established and exhausted by the standard categories of agent, trustee, partner, director and the like. I do not agree. It is the nature of the relationship, not the specific category of actor involved that gives rise to the fiduciary duty. The categories of fiduciary, like those of negligence, should not be considered closed. The Alberta Court of Appeal, in Anderson, Smyth and Kelly Customs Brokers Ltd. v. Worldwide Customs Brokers Ltd., 5 commented upon the evolution of the law of fiduciaries and its impact upon the determination of fiduciary obligations in the employment context and O Leary J.A. stated The law has moved away from the use of formal and recognized relationships as limiting the circumstances in which fiduciary obligations may be found. The substance of the relationship between the parties is critical not the nomenclature used to describe it. There are now few obstacles to characterizing an employee as a fiduciary of his employer. Accordingly, it now seemed that it was less important to establish that an employee had taken advantage of a particular business opportunity or even that the employee was a member of top management. B. A Change of Direction The trend towards increasing the fiduciary obligations of employees experienced a sharp reversal in the British Columbia Court of Appeal decision in Barton v. Irwin et al. 6 In Barton, the Defendant Irwin had been the employee of the Plaintiff insurance agency for a number of years, during which time she acted in the capacity of a producer selling and servicing insurance to customers but also for a period of time as branch manager of one of the Plaintiff s branches. The Plaintiff terminated the Defendant s role as branch manager and the Defendant took employment with a competitor following the resignation of her employment. Thereafter, the Defendant with the use of telephone book identified over 400 customers of her 3 (1985) 6 C.P.R. (3d) 173 4 (1984) 13 D.L.R. (4th) 321 5 [1996] 7 W.W.R. 736 6 (1999) 40 C.C.E.L. (2d) 159, 170 D.L.R. (4th) 69
p. 5 former employer, contacted them by letter and telephone and succeeded in persuading over 200 of them to switch their business to her new employer. The Plaintiff alleged that the Defendant Irwin was a fiduciary and that her new employer was also liable. Both the trial Court and the British Columbia Court of Appeal held that the Defendant Irwin was not a fiduciary. The Court, after observing that if some restriction on an employee s scope of action post-employment is thought to be desirable, then the employer could and perhaps should pursue an enforceable restrictive covenant, referred back to Canadian Aeroservice Ltd. v. O Malley and the emphasis placed on the fact the defendant fiduciaries were senior officers. The Court referred to an Ontario case from 1977, Edgar T. Alberts Ltd. v. Mountjoy 7 for the finding that persons occupying positions of directors or senior management may be found to be subject to a continuing fiduciary duty to a former employer. Such a duty often encompasses a prohibition on solicitation of former customers. However, other employees will not necessarily be so restrained. The Court went on to say that it would not necessarily agree with the proposition set out in Anderson that virtually any employee could be found to be a fiduciary. Finally, the Court held that absent an enforceable agreement to refrain from soliciting former customers, I am not of the view that any duty, fiduciary or otherwise, should have been found to prevent Ms. Irwin from canvassing former clients. In cases involving activity by key or senior former employees, or by directors in situations disclosing manifest unfairness a Court may be persuaded to grant injunctive relief or to award damages against former employees. However, the general interest of the public in free competition and the consideration that in general citizens should be free to pursue new opportunities, in my opinion, requires Courts to exercise caution in imposing restrictive duties on former employees in less than clear circumstances. In certain circumstances, which I think would be relatively rare, a former employee of less than senior management of directorial status might be found subject to a fiduciary duty for instance a key employee finding might serve to found such a duty. But I do not believe the Court should be easily persuaded to find that ordinary employees would be subject to continuing duties. Of course, Courts will always be prepared to act to prevent manifest unfairness. (Emphasis Added) The unanimous decision of the Court suggests that unless an employee is either a manager or director, it will be a rare circumstance in which he or she will be found to be a fiduciary. The Court emphases the weight placed by the Supreme Court of Canada in Canadian Aeroservice Ltd. v. O Malley et al on the significance of the manager/director relationship. The Court does 7 (1977) 16 O.R. (2d) 682, 36 C.P.R. (2d) 97
p. 6 not completely close the door on a finding that a key employee who is neither a manager or director could still be a fiduciary but suggests that for there to be such a finding there must be a clear demonstration of manifest unfairness in favour of the employer. It can be seen that for an employer to succeed in establishing breach of fiduciary duty against a former employee, it should focus on: 1. The importance of the position held by the former employee and it s managerial characteristics; 2. Whether the employee was an officer of director; 3. The nature of the business appropriated; 4. Whether any steps were taken against the employer s interest by the employee during his employment; 5. Whether or not the employee took documentation, computer software, or other confidential information with him. C. If a fiduciary relationship is established, is the fiduciary prohibited from any solicitation of customers? Direct solicitation of clients by a former fiduciary employee will probably constitute a breach of fiduciary duty. Much will depend on how the courts view the customer as a corporate opportunity. For example, it seems clear that where an employee finds out through his employment that his employer has submitted a bid of $50,000.00 for a piece of work with a customer and then leaves his employment and uses that inside information to undercut his former employer, he will have breached his fiduciary duty. An important factor is the form of the solicitation. It is probable that the solicitation of the former employer s customers would not be objectionable if it is part of a general solicitation of the public, for example, a promotional flyer mailed out to all purchasers of a particular product in a given area. Of particular importance is the activity of the departing fiduciary employee prior to his departure. Almost any step taken by the employee against the employer s interest before the departure of the employee will weigh heavily in favour of the employer is subsequent allegations of breach of fiduciary duty. D. Is there a cause of action against a new employer? Certainly if a former fiduciary employee incorporates a company in order to complete with his former employer, the new corporate vehicle will be subject to the same restraints as the former
p. 7 employee. If he sells his services to an arms length employer the courts may grant injunctive relief against both the former employee and the new employer. E. Does it matter whether the fiduciary employee was terminated or resigned? While the authorities conflict somewhat in this area, a number of cases have held that an employer who dismisses a fiduciary without cause will not have any remedy if that person subsequently solicits his customers. The courts, in these circumstances, are more likely to give greater weight to the element of restraint of trade and the rights of the employee to sell his labour. F. Does the fiduciary obligation last indefinitely? In circumstances where the courts would find that a fiduciary should not compete with his former employer, it will limit that obligation to a reasonable period of time. The time will vary depending on the circumstances of each case. In most cases, a year to 18 months seems to be typical. G. Can a former employee solicit other employees after his departure? Generally, the courts will grant injunctive relief if there is evidence that the former employee has induced other employees to breach their contracts of employment. However, a careful former employee might induce employees to give reasonable notice of resignation and in this way, the courts might find that there was no breach of the contract of employment in departing. Generally, except in obvious cases, it is difficult for an employer to succeed in this cause of action. H. Remedies The two remedies for breach of fiduciary duty are injunction and damages. Injunctive relief is more difficult to obtain, particularly interlocutory relief to bar conduct pending trial, in that the applicant, in addition to establishing the basic facts necessary to support the injunction, will be required to persuade the Court that it is likely to suffer irreparable harm if the injunction is not granted and that, on a balance of convenience, the injunction should be granted. Where the conduct complained of does not go to the heart of the applicant s business, the courts will likely conclude that the plaintiff will be sufficiently compensated if it recovers damages at trial. Obviously, a successful interlocutory injunction will increase the chances of securing a permanent injunction at trial and vice-versa.
p. 8 I. What is the effect of delay? Delay on the part of a former employer in taking steps to prevent a former employee from soliciting customers will often be fatal to an application for an injunction. It will, however, have little or no effect on the right to claim damages unless the claim is made outside a limitation period. Further, delay in enforcing rights may deprive the former employer of remedies against third parties who pay good money for value without knowledge of the former employer s rights. Employers who feel they have actions for breach of fiduciary duty should assert their rights at the earliest stage possible if they wish to preserve all remedies. David W. Buchanan, Q.C. Post Employment Competition and Customer Solicitation T. 604.687.5700 CWA87475.1