Competition is Fierce—Restrictive Covenants in the Shafron Case

Valerie Dixon | September 14, 2009

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• Competition is Fierce—Restrictive Covenants in the Shafron Case
• Internet Use (To Catch Abuse)
• Facebook Litigation Grows
• Proof—Roles of Adjusters and Lawyers in Fidelity Recovery
• Best Practices for Successful Subrogation Recoveries
• State of Securities Class Actions
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• Misguided Critique of Covert Surveillance
• Employee Termination—A Risk You Can Manage
• Using Data Analytics to Maximize Company Performance
• Give It Up—Vehicle Fires & Frauds
• Overview of Detection & Investigation Techniques

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Competition for clients is fierce in the insurance brokerage industry. Experienced producers with established books of business are highly sought after and the question of “who owns the clients” is one that will inevitably be asked when an insurance agent leaves his or her employer and joins a new one (or, in some cases, sets up their own shop).

Most insurance agencies insist on producers signing employment contracts that include non-competition or non-solicitation clauses (both of which are also known as restrictive covenants).  These contractual terms restrict the employee’s right to compete with their former employer after the employment is terminated. However, restrictive covenants must be very carefully drafted to be enforceable.

A couple of recent cases illustrated this point; the courts did not hesitate to strike down restrictive covenants, which failed to conform to the established principles. As a result an employer can be left with little or no protection against competition by the former employee.

It is interesting to note over the last 30 years the Supreme Court of Canada has considered only two cases, which deal with restrictive covenants in employment contracts. Both of those cases dealt with disputes between producers and their former employers. This, despite the fact that because of the highly competitive nature of the industry, disputes between insurance brokerages and former producers make up a significant portion of judgments, in this area.

Is a Restrictive Covenant Enforceable?

Whether a restrictive covenant is enforceable will depend on number of factors. Because restrictive covenants are considered to be contracts in restraint of trade (and thus contrary to public policy), they are presumed to be void unless the employer can demonstrate that there is a legitimate interest to protect and that the protection is reasonable in the particular circumstances.

The courts have generally held that a restrictive covenant must meet the following basic requirements before it will be deemed enforceable:

1. It protects a legitimate proprietary interest of the employer;
2. The restraint is reasonable between the parties in terms of
      (a) temporal length,
      (b) spatial area covered,
      (c) nature of activities prohibited, and
      (d) overall fairness;
3. The terms of the restraint are clear, certain and not vague; and
4. The restraint is reasonable in terms of the public interest with the onus on the party seeking to strike out the restraint.

The basic rationale for such a hard line approach to restrictive covenants is that in most, if not all, employer/employee relationships there is an inequality of bargaining power and the opportunity for oppression, duress, or undue influence to be present. Such a power imbalance may not always exist, especially where the producer is a very senior or key employee. However, even where a producer is considered to be a fundamental component of a successful brokerage, the court in most cases will still adhere to the basic principles set out above.

Two Recent Cases Offer Insight

Two recent cases provide useful illustrations of restrictive covenants in the insurance brokerage context.

In H.L. Staebler Company Limited v. Allan, (2008 ONCA 576), the defendant producers were subject to a restrictive covenant, which read as follows:

In the event of termination of your employment with the Company, you undertake that you will not, for a period of 2 consecutive years following said termination, conduct business with any clients or customers of H.L. Staebler Company Limited that were handled or serviced by you at the date of your termination.

After several years of employment, the two producers left Staebler and accepted positions with a competitor brokerage. Over the next few months, approximately 118 clients moved their insurance business to the producers’ new firm. Not surprisingly, Staebler sued and relied on the restrictive covenant shown above.

At trial, Staebler was successful and the producers were found to have breached the restrictive covenant. But the producers appealed and on August 6, 2008, the Ontario Court of Appeal released its reasons for judgment in which it held that the restrictive covenant was unenforceable and therefore the claim against the producers failed. The rationale for the court’s decision was: Because the restrictive covenant had neither a geographical limit nor a limit on the type of work the employees were prohibited from conducting with former clients, the covenant was unenforceable. Staebler sought leave to appeal to the Supreme Court of Canada, but was denied.

More recently, the Supreme Court of Canada released a decision dealing with the issue of restrictive covenants in employment agreements: Shafron v. KRG Insurance Brokers (Western) Inc., (2009 SCC 6).

Shafron was an insurance salesperson and had owned his own brokerage in the South Granville area of Vancouver since the early 1960s. In 1987, he sold his business to KRG Insurance Brokers Inc. but stayed on as an employee, continuing his successful career as a producer. In 1991, the business was sold again, this time to Intercity Investment Corporation, which purchased the shares of KRG Insurance Brokers (Western) Inc., Shafron’s employer. In 1991, prior to Intercity’s purchase of KRG, Shafron signed an employment contract that included a restrictive covenant which read as follows:

Shafron shall not, upon his leaving the employment of the Corporation [KRG Western] for any reason, save and except for termination by the Corporation or KRG Management without cause, for a period of three (3) years thereafter, directly or indirectly, carry on, be employed in, or be interested in or permit his name to be used in connection with the business of insurance brokerage which is carried on within the Metropolitan City of Vancouver.

In December 2000, Shafron left the employ of KRG and began working as an insurance salesman for Shaw Insurance Agency in Richmond, BC.

KRG commenced an action against Shafron for, among other things, breach of the restrictive covenant. The claim was dismissed.

The trial judge found, in particular, that the restrictive covenant’s reference to the “Metropolitan City of Vancouver” (which had no legal definition) was neither clear nor certain and in any event was an unreasonable restraint on Shafron’s ability to compete against his former employer.

On appeal to the BC Court of Appeal, the trial judge's decision was over turned. Using the "doctrine of notional severance", the court determined that it was able to interpret the restrictive covenant to cover the City of Vancouver, the University of BC endowment lands, Richmond and Burnaby.

Shafron sought and was granted leave to appeal to the Supreme Court of Canada. In allowing the appeal and restoring the judgment of the trial judge, the Supreme Court very clearly enunciated several principles:

• A contractual term which limits an employee's right to compete with its former employer (a restrictive covenant) is on its face unenforceable unless is can be proven to be reasonable in terms of subject matter, geographical and temporal scope.
• The language of the restrictive covenant must be unambiguous. If a restrictive covenant is ambiguous, it cannot be cured by the Court.
• The Court cannot simply add or delete words (using the "doctrine of notional severance") in a restrictive covenant in an employment agreement to render it unambiguous or reasonable.
• The Court cannot impose upon the employee and employer a bargain that they could have but did not make for themselves.

Ultimately, the Supreme Court of Canada found that since the term "Metropolitan City of Vancouver" was neither clear nor certain and thus the restrictive covenant could not be enforced. Since no evidence had ever been adduced as to what the parties believed "Metropolitan City of Vancouver" to mean, the court concluded that it could not step in and impose a bargain that the parties themselves had not made.

Insurance agencies have perfectly legitimate business interests to protect by way of restrictive covenants in employment agreements or purchase and sale transactions. If the proper protection is to be obtained, both the Staebler and Shafron cases emphasize the importance of having these sorts of restrictive covenants drafted by lawyers with real expertise in this area of the law.

Employers (and their lawyers) must ensure that restrictive covenants are drafted only as broadly as absolutely necessary, and any attempt to over reach may mean that the court will simply strike the clause down.

Valerie Dixon is a senior associate with Clark Wilson LLP in Vancouver and is a member of the firm's Insurance and Labour & Employment groups. She acted in the Supreme Court of Canada as co-counsel for the successful appellant in the Shafron v. KRG Insurance Brokers (Western) Inc. case.