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British Columbia Employer Advisor Keeping Employers Posted on Developments in Labour and Employment Law

BCCA Eyes Enforceability of Restrictive Covenant in IRIS Appeal

Posted in Best Practices, Employee Obligations, Employer Obligations
Christopher McHardy

Restrictive covenants are often a key component of employment agreements and commercial transactions. Enforceability, however, can be challenging, especially in the employment context.  The B.C. Court of Appeal’s recent decision in IRIS The Visual Group Western Canada Inc. v. Park, 2017 BCCA 301, is a good reminder and provides valuable insight into several related legal principles.  The implications of the decision will be of interest to many B.C. employers who rely on restrictive covenants or who are contemplating doing so.

Background

IRIS The Visual Group Western Canada Inc. (“IRIS”), an eye care services provider and eyewear products vendor, operated its business by entering into Optometric Services Agreements (“OSAs”) with individual optometrists to deliver its services and products to customers.  IRIS concluded such an agreement with a certain Dr. Park.  In the agreement, Dr. Park agreed and acknowledged she would provide services as an independent contractor.  The agreement also included a non-competition clause that prohibited Dr. Park from competing with IRIS, whether directly or “in partnership or in conjunction with” any person or company “carrying on, engaged in, interested in or concerned with a business that competes with” IRIS within 5 km of the IRIS location in Vernon where Dr. Park provided services.  The clause also prohibited Dr. Park from being “engaged” or “employed” by any competing persons or companies, subject to the same temporal and geographic constraints.

Dr. Park eventually resigned in order to set up her own practice. She requested that IRIS release her from the non-competition clause, but IRIS refused.  She proceeded to set up her own practice nonetheless, about 3.5 km from the IRIS location where she previously worked.  IRIS then brought an action against Dr. Park seeking a declaration that the non-competition clause was valid and enforceable, and for an injunction preventing her from competing with IRIS within 5 km of its Vernon location.

B.C. Supreme Court Decision

At trial, the B.C. Supreme Court found that because the non-competition clause was a restrictive covenant, the onus was on IRIS to show the restriction was reasonable as between the parties. The judge determined that the OSA was closer to an employment contract than an agreement to sell a business, and accordingly gave the agreement the closer scrutiny that employment relationships attract.  The judge concluded that the temporal and geographic limitations were reasonable, but that the clause was overly broad in terms of the activities it proscribed. Accordingly, the judge declined to enforce the clause.  IRIS appealed.

B.C. Court of Appeal Decision

Three issues were raised on appeal:

  1. Did the trial judge err in characterizing the OSA as an “employment agreement” and consequently scrutinizing the agreement more rigorously?
  2. Did the trial judge err in finding the non-competition clause was unreasonable in terms of the scope of activities it prohibited?
  3. If the non-competition clause was unreasonable as drafted, did the trial judge err in declining to use the “blue-pencil rule” to make the clause reasonable?

(1)  Heightened Scrutiny Test

The Court of Appeal affirmed that agreements containing the elements of an employment relationship – namely, the absence of a payment for goodwill and a power imbalance between the parties – warrant greater scrutiny, as compared to agreements for the sale of a business. Although Dr. Park had been characterized as an “independent contractor” in the agreement, that characterization did not shelter the agreement from stricter scrutiny, as there was no goodwill payment and there was a power imbalance between the parties favouring IRIS. In finding there was a power imbalance, the Court cited the fact that IRIS set Dr. Park’s hours, controlled her vacation time, set the fees she charged, and required that all patient files be transferred to another IRIS optometrist upon termination of the OSA. The Court also noted Dr. Park’s relative inexperience and lack of client base, factors that further suggested a power imbalance. Accordingly, the Court concluded it was appropriate to give the non-competition clause rigorous scrutiny.

(2)  Scope of the Non-Competition Clause

The Court affirmed that IRIS bore the onus of demonstrating that the non-competition clause was cast no more broadly than necessary to protect the legitimate interests of the company, the key interest here being IRIS’s trade connections. The Court noted that in addition to a non-competition clause, the OSA had included a non-solicitation clause and a provision requiring Dr. Park to transfer her client list and files to another IRIS optometrist upon her departure. Both of these provisions provided some protection for IRIS’s trade connections. In the main, however, there were two key issues with the non-competition clause that made it unreasonable:

  • First, the clause was ambiguous. The Court wondered what it meant to compete “in conjunction with” another person, as well as how one would determine whether an individual was “concerned with” a competing business.
  • Second, the clause went beyond what was necessary to protect IRIS’s legitimate interests. If enforced, the clause would prevent Dr. Park from engaging in a wide range of work, including work that had nothing to do with the practice of optometry, such as working with a business that dispenses non-prescription eyeglasses or sunglasses.

Accordingly, the Court concluded that the non-competition clause was not reasonable, in so far as it was ambiguous and overly broad, and therefore was not enforceable.

(3)  Severability

Finally, the Court considered IRIS’s argument that the non-competition clause could be salvaged by employing the “blue pencil rule” or “blue-pencil severance”. IRIS argued that the court should give effect to the parties’ intentions and should make the restriction reasonable by striking out part of the clause to narrow the list of prohibited activities to working with a business that dispenses prescription optical appliances. The Court noted that courts are disinclined to fix defective non-competition clauses by severing offending language. It was confirmed that courts will have recourse to blue‑pencil severance only in cases where the part being removed is “clearly severable, trivial and not part of the main purport of the restrictive covenant”. In IRIS, the court found that blue-pencil severance could not be performed for two reasons:

  • First, trimming the clause in the manner suggested by IRIS would go to the “main purport” of the restrictive covenant, as the company had clearly intended to prevent Dr. Park from competing with it in any way, however remotely. The Court found it would be inappropriate to effectively rewrite the agreement to create a more moderate restriction that did not reflect the parties’ intentions.
  • Second, the Court noted that the “fix” suggested by IRIS would not resolve the ambiguity created by words of association such as “in conjunction with” or “concerned with a business”.

Accordingly, the Court declined to perform blue-pencil severance.

Key Takeaways

There are at least three key lessons that B.C. employers can take away from this case:

  1. An independent contractor agreement will likely be subject to the same degree of scrutiny as an employment agreement. IRIS makes clear that courts will focus on whether the policy rationale for the strict scrutiny given to employment agreements – arising from a power imbalance and the absence of a goodwill payment – is present. If the policy rationale exists, strict scrutiny will follow. IRIS also provides some indication of the sorts of factors that courts may consider when determining whether an imbalance of power exists in cases involving professionals. These factors include the professional’s experience, the level and depth of client base at the time the agreement is entered into, the professional’s ownership and/or control over the client relationships and files, and the employer’s level of control over matters such as working hours, vacation time, and billing rates. Many other factors may also be considered.
  2. Employers must take great care to ensure any restrictive covenant goes no further than is necessary to protect the legitimate interests of the company. This means ensuring, among other things, that the restriction is clear and appropriately constrained in terms of the scope of activities restricted, the length of time during which the restrictions operate, and the geographical scope of those restrictions. In terms of clarity, the Court of Appeal in IRIS emphasized at several points in its decision that the words “in conjunction with” and “concerned with” a business were ambiguous in meaning. This is somewhat surprising given that those terms are likely found in many agreements. It also shows that courts have wide latitude in interpreting restrictive covenant language and can easily take issue with a covenant. Accordingly, in addition to ensuring that the covenant is not overly or unnecessarily restrictive, employers should pay close attention to the language they use – plain language is beneficial.
  3. Courts are reluctant to resort to blue-pencil severance to salvage a defective non-competition clause. Unless it can be demonstrated that the part sought to be removed is clearly severable, trivial, and not part of the “main purport” of the clause, the court will not consider striking portions to make the restrictive covenant reasonable. Hence, it is essential that employers “get it right the first time” and draft an unambiguous, reasonable restriction.

Given the challenges that this area presents, employers are also well advised to seek legal advice on restrictive covenants, especially if such protections are very important to the business.

*This blog was written with the assistance of Connor Bildfell, Articling Student.