Non-Competition Clause Breached by Business Vendor

Non-competition clauses are often found in employment contracts and commercial agreements, particularly relating to the sale of a business. While non-competition clauses remain contrary to public policy at common law and may be unenforceable, an exception to the general rule against this restraint of trade sees courts enforcing these clauses in cases where their scope is reasonable.

In a recent decision, the Court of Appeal of Alberta upheld a trial judge’s findings that a non-competition clause was enforceable and an essential term to the business sale agreement that the vendor had breached.

Are non-competition clauses enforceable?

A non-competition clause is a restrictive covenant often found in employment contracts and business sale agreements. They prohibit vendors from competing with business purchasers and prevent employees from competing with their former employers. However, these types of clauses raise public policy concerns by pitting the principles of freedom of contract against the restraint of trade. As a result, parties often disagree on whether a non-competition clause is enforceable and, if so, whether it has been breached.

In the case of Payette v. Guay, the Supreme Court of Canada held that a non-competition clause may be reasonable in a commercial context when it is:

“… limited, as to its term and to the territory and activity to which it applies, to whatever is necessary for the protection of the legitimate interests of the party in whose favour it was granted.”

Share purchase and sale agreement contains non-competition clause

In Ruel v. Rebonne, the respondent Ruel purchased the home decor business Down the Beaten Path (“DTBP”) from the appellant Rebonne and his business partner. DTBP was a wholesale business that imported home decor items from Mexico for distribution to retailers across Canada. It was operated by a numbered company, and the respondent purchased the shares in the numbered company in July 2014 for $350,000. The Share Purchase and Sale Agreement (the “Agreement”) was between the numbered company as the vendor corporation, the appellant and his business partner as vendors, and the respondent as the purchaser.

The Agreement included a non-competition clause which prohibited the vendors from competing with the DTBP in Canada for five years. It also forbade the vendors from:

• Soliciting DTBP’s customers;
• Providing goods or services to customers that DTBP could provide; and
• Acting in a way that would be detrimental to the relationships between DTBP and its customers.

Allegations of breach of non-competition clause

The appellant continued to work with DTBP after the sale to help facilitate a smooth transition to the new owner. He was later hired as a commissioned salesperson with DTBP.

However, the relationship between the appellant and respondent had deteriorated by September 2017. The appellant stopped working for DTBP and joined a new company he had incorporated called Mood Dekor, which engaged in similar business as DTBP. The respondent alleged that the appellant continued to sell products to DTBP customers through his new company and acted contrary to the non-competition clause. Further, he claimed the fiduciary duties and common law duty of confidence owed to him by the appellant had been breached.

Trial judge awards damages for breach of contract and mental distress

The appellant claimed that the non-competition clause was unreasonable, ambiguous, and therefore unenforceable. He also argued that if the restrictive covenant was enforceable, he did not breach it or any of the fiduciary duties the respondent claimed were owed to him. Further, he argued that the respondent had not established that he had suffered damages due to a breach and sought dismissal of the claim.

At trial, the evidence showed that Mood Dekor used the same suppliers as DTBP, purchased the same or similar products as DTBP, and sold the products to Canadian customers of DTBP. As a result, the trial judge awarded the respondent damages for breach of contract and mental distress, writing:

“The inclusion of a non-completion clause in the Agreement was an essential part of the deal to purchase Down the Beaten Path for Mr. Ruel [the respondent]. He recognized that the biggest threat to the ongoing success of Down the Beaten Path was other companies doing what Down the Beaten Path was doing and selling to his Canadian clients.”

Court of Appeal confirms non-compete clause was an essential term of business sale

The vendor, Rebonne, appealed the trial judge’s decision. The Court of Appeal considered if the non-competition clause was enforceable and whether the appellant had breached the non-competition clause by selling products to customers of DTBP.

On review, the Court of Appeal noted that the validity of a non-competition clause is a question of law and determining its lawfulness is based on whether the scope of the clause is, on the balance of probabilities, reasonable or not. The Court found that the trial judge applied the correct legal test, and the clause was reasonably restrictive as it related to the activities of DTBP, the business territory, and the duration of the restriction. The Court also highlighted that the trial judge acknowledged the non-competition clause was an “essential” term of the business sale and was “necessary for the protection of the respondent’s legitimate interest in maintaining the value of the business.”

Based on this, the Court dismissed this ground of the appeal after finding no error of law, giving deference to the trial judge’s findings.

Court of Appeal rejects argument that sales in U.S. do not contravene non-competition clause

The Court then turned to the second ground of appeal, wherein the appellant argued that the trial judge erred in finding that the non-competition clause was breached. He argued that when he made sales at trade shows in the United States, the sale did not occur “in Canada”; therefore, he did not breach the clause that only restricted sales “in Canada”.

The trial judge rejected this argument after concluding that Mood Dekor “operated in Canada and sold home decor products to Canadian customers” of DTBP. On appeal, these findings are only reviewed for palpable and overriding error. However, the appellant failed to identify a reviewable error in the trial judge’s interpretation of the Agreement of the findings of fact. Therefore, the Court of Appeal dismissed this ground of appeal.

Expectation damages calculated appropriately

The appellant further argued that the trial judge erred by ordering the disgorgement of Mood Dekor’s profits. However, the Court disagreed with this characterization of the order. On review, the Court found that the trial judge had applied the ordinary rule and, when measuring damages, put the respondent in the position he would have been in if the contract had been performed.

Since there was no way to calculate precisely how DTBP would have performed without the appellant’s breach, the Court agreed that the trial judge’s use of Mood Dekor’s gains to measure DTBP’s lost profit was an appropriate method to calculate expectation damages. This ground of appeal was dismissed.

Appeal allowed for mental distress damages

The final ground of appeal concerned the trial judge’s purported application of the incorrect legal test when awarding damages for mental distress for breach of contract. The test set out by the Supreme Court of Canada in Fidler v. Sun Life Assurance Co of Canada requires that the court must be satisfied that:

1. An object of the contract was to secure a psychological benefit that brings mental distress upon breach within the reasonable contemplation of the parties; and
2. The degree of mental suffering caused by the breach was of a degree sufficient to warrant compensation.

The Court of Appeal found that the trial judge “did not articulate” the legal test, nor did he refer to case law when making this award. It was also determined that he did not find that the object of the Agreement was to “secure a psychological benefit to the respondent that would have brought mental distress upon breach.” Therefore, the Court held that the trial judge erred in awarding this head of damages.

Contact the Commercial Litigation Lawyers at DBB Law in Calgary for Advice on Restrictive Covenants in Business Sale Agreements

The skilled commercial litigation lawyers at Dunphy Best Blocksom LLP in Calgary frequently represent clients in commercial contract negotiation and litigation by minimizing risk and protecting clients’ interests. When commercial disputes involve employment matters, such as in the case of a business sale, our experienced litigation team also advises both employers and employees on various employment law matters. To learn how we can assist you with your commercial litigation or employment dispute, contact us by phone at 403-265-7777 or complete our online form.