Bill 27’s insertion of its Non-Compete Agreement section into Ontario’s Employment Standards Act (“ESA”) came into force on October 25, 2021. As Parekh et al v. Schecter et al, 2022 ONSC 302, swiftly pointed out, the ESA’s new prohibition against non-compete clauses only applies to employment agreements entered into on or after this date. I.e., this new statutory prohibition does not take retrospective effect prior to October 25, 2021. This will lead to a quite lengthy tail period for at least some employment agreements before the new prohibition on non-compete clauses in the employment context is fully effective. Nonetheless, Bill 27 has started a transition process that is removing a cheap and effective, yet too often abused, tool used to prevent unfair competition.
Broadly speaking, the major use of non-compete agreements is to legally protect the right to own or control intangible assets. Agreements prohibiting the solicitation of customers aside, confidentiality obligations and trade secrecy represent the other broad avenue for legal protection here. Accordingly, I predict that this phasing out of non-compete clause will place trade secrecy and breach of confidence front and centre. While there is a higher front-end need for evidence of wrongful conduct, confidentiality claims are a key mechanism to warding off bona fide cases of unfair competition from departing employees and business partners. In fact, the remedy for breach of non-compete covenants and confidentiality obligations more or less overlap.
Another issue is the various exceptions to the scope of Bill 27’s amendments to the Employment Standards Act. Business-to-business non-compete agreements obviously fall outside of its scope. And within the sphere of employment, Bill 27 also preserves two major exceptions to its prohibition on non-compete agreements relating to the sale of a business and executive employees. As such, while the hold that non-compete agreements had on “regular” employees, including skilled experts, will now be diminishing, non-compete clauses will remain a feature of Ontario’s landscape for the foreseeable future. It is therefore important to have a solid grasp on just what the Bill 27 amendment to the ESA does and does not do.
I will outline this below, while taking the opportunity to meditate on the different means of protecting various forms of intangible assets. But first, I would like to illustrate why the intersection between confidentiality obligations and non-compete provisions matters via a detour into Californian law.
California and the Trade Secret Exception
California law famously disallows most forms of non-compete agreements affecting individuals, particularly in employment agreements. Further, there is robust social scientific evidence that allowing knowledge workers to be fettered in this way tends to reduce labour mobility and dampen innovation, notably in the tech industry. The absence of this type of restriction in California very much appears to have contributed to the rapid dissemination of ideas within Silicon Valley relative to other tech corridor hopefuls. I have not looked into the topic recently, but R.J. Gilson’s 1999 “The Legal Infrastructure of High Technology Industrial Districts: Silicon Valley, Route 128, and Covenants Not to Compete” and A. Hyde’s 1998 “Silicon Valley’s High-Velocity Labor Market” remain seminal works in the area.
Bill 27’s Non-Compete Agreement section is not limited to the tech industry. Nonetheless, one suspects that its genesis came about because the Ontario legislature wanted to take a page out of California’s playbook now that the Big Tech has rolled into Toronto in a serious way. Start-up activity will, hopefully, bloom.
While I am by no means an expert in Californian law, a little light Googling shows that trade secrets are often described as an “exception” to the prohibition on non-compete agreements. I suspect trade secrecy is not an exception to California’s general prohibition on non-compete agreements per se. The terminology appears to crop up in California due to litigation regarding whether a contractual clause truly protects the misuse of trade secrets or is instead one of the forms of restrictive covenants prohibited there.
Regardless, the bottom line is that an individual departing with and misusing secret or confidential information is committing a legal wrong. While the Canadian law of confidentiality is more broadly pitched, in the commercial context the root issue is typically some form of unfair competition. As such, when an employee or erstwhile business partner misuses secrets one frequently ends up in a similar place as when seeking to enforce a non-compete clause.
Preserving (Some) Legitimate Uses of Non-Competition Agreements
To return to Canada, many law firm pages or blog posts mention at some point that, even prior to Bill 27, non-competition clauses are “generally unenforceable” or were “not treated favourably” by the courts. These statements are, on a legal doctrinal level, technically true in terms of how judges approach scrutinizing restraint on trade type clauses. And prior to Bill 27, Ontario, like Canada generally, has seen an intensifying tendency to insert non-compete clauses into the employment contracts of people with essentially normal jobs. Even for skilled professions earning more than comfortable wages, the courts will often – but not invariably – frown on non-compete clauses restricting their post-employment activity.
But I do want to caution that, like most restrictive covenants, there are well recognized instances where non-competition agreements are dependably enforceable. Not surprisingly, these two areas match the exceptions carved out of Bill 27’s non-compete amendments to Ontario’s ESA.
(a) Sale of a Business
Firstly, the law is typically willing to enforce relatively broad non-compete agreements in the context of a sale of business. The thinking tends to be that there is mutual advantage to a legal mechanism that allows the prospective former owner to effectively hand over the keys when negotiating the price and other key terms.
In this context, non-compete agreements are best seen as a tool that allows “goodwill” – intangible and often non-quantifiable assets such as customer loyalty and brand reputation, but also related forms of confidential information such as customer and marketplace knowledge as well as technical or operational know-how – to be effectively (if somewhat notionally) “transferred” to the new owner. If, for example, the former owner is feeling bored or ornery six months after the sale and is free to start using his personal knowledge and contacts to re-set up a competing operation, the rationale for the deal bargained for breaks down. Bill 27 uncontentiously preserves this sale of a business use of a non-compete agreement.
(b) “True” Senior Executive Positions
Secondly, the law is typically willing to enforce narrower non-compete agreements respecting what might be thought of as true CEO or senior executive position. This area tends to be intertwined with fiduciary duties, and the special vulnerability that a company faces relative to an individual who act as its key decision maker and public face. Genuine fiduciaries normally must respect a cooling-off period after departing a company. In this context, a non-compete agreement can be seen as negotiating over just what this cooling down period should look like. Finally, if one is about to enter into an executive-type employment agreement, one is often genuinely negotiating, for example, the size of the golden parachute on termination versus stock options or other perks.
Ontario is not willing to embrace the free movement of labour California style. In this context, I can understand why an executive employee exception was carved out.
(c) Executive Title Creep
Nonetheless, I anticipate Bill 27’s use of the term “executive” employees as an exception to the general prohibition on non-compete agreements will be the subject of recurring litigation. To wit, it does not necessarily follow that being given a C-suite title such as, for example, Chief Information Officer, means that one is actually an upper-echelon decision maker or had the opportunity to negotiate an executive level employment agreement. Particularly at a start-up or smaller company, a CIO may simply be the senior programmer or IT staff member.
I have seen a fair amount of legal advice to the effect that companies should adjust their C-suite titles to fit within the new ESA framework on non-compete agreements. Fair enough. But slotting an individual within the ESA executive employee exception does not immunize the non-compete agreement in question from the usual challenges to its enforceability under the common law.
Banning Boundary Cases
The main virtue in Bill 27’s amendments to Ontario’s ESA is to, I would suggest, usefully ban the creeping normalization of non-compete agreements being inserted into employment agreement for “normal” positions. In this context, by normal I include highly skilled or paid positions in, for example, medicine, engineering, or the tech industry. Bill 27 also notably lacks any exception for experts involved in research and development.
(a) Research and Development Experts
Technically skilled individuals who outright work in research and development – direct efforts to create new methods of doing things as a form of knowledge asset – have long faced employers who insisted on non-competition clauses. In the case law, this tendency can be traced as far back as the mid-1800s and the very origins of trade secret law, and it appears to have intensified with the rise of corporate research departments in the early twentieth century.
I would suggest that requiring R&D experts to enter into non-compete agreements represents an effort to create an easily enforceable right designed to mitigate the risk that such individuals will “take” the trade secrets they have learned or personally developed with them when they depart for greener pastures. A blanket, if time and geographically limited, restriction on working within the industry provides a measure of assurance that the firms and investors who provide capital for this sort of R&D activity will be able to capture the benefit. Yet, as discussed above, even time-limited restrictions on the free flow of expert knowledge have a cumulative cost to not only the expert in question, but society.
Again, if there is a concrete reason to believe that a departing expert is breaching obligations relating to trade secrecy or confidentiality, this is already an actionable wrong.
(b) Ordinary Employment Positions
As the Supreme Court of Canada periodically points out, the unequal bargaining positions between employers and employees marks most employment relationships. While its normal to dicker over the salary figure or vacation before accepting a position, in practice most terms are not so much freely negotiated as set by your employer, and employers within an industry in general. Executive contracts are the exception rather than the rule.
As one of my favorite legal academics, Karl Llewellyn, pointed out circa 1960, a recurring problem in the private law is that very legitimate contractual clauses are developed to reduce certain legal risks and to enable certain operational advantages. Initially these clauses are used within sensible boundaries. But “either at once or over the years, and often by whole lines of trade” such clauses spread and develop a terrifyingly and one-sided character requiring “one party [to] lay his head into the mouth of a lion.” While Llewellyn made this point in the context of standard form contracts, I would suggest that the point applies to the increasingly prevalent insertion of non-compete clauses into regular employment contracts.
While the point is difficult to prove, my sense is that the rise of the information economy and knowledge workers has brought along with it an increased awareness and desire by businesses to protect their “goodwill” and other intangible or knowledge-based assets. This is certainly legitimate – and, as I have argued, confidentiality obligations remain a crucial and legitimate tool in defending everything from customer and market information to hard-won technical expertise. Yet the alternative legal protection of unfair competition via unbending non-compete provisions fettering broad classes of workers brings with it too many costs.
The Bottom Line
Possible gamesmanship relating to the executive exception aside, Ontario’s Bill 27 amendment to the ESA is in the process of removing the ability of employers to simply insist that their employees enter into non-compete clauses. This is, on balance, to the good. Other, more targeted legal protections remain available, including non-solicitation clauses and my own area of expertise, confidentiality and trade secrecy obligations. It will be interesting to see if other provinces follow suit.