Restrictive Covenants In M&A Transactions: Drafting Enforceable Non-Compete Clauses

• Published date: 18 May 2022
• Subject Matter: Corporate/Commercial Law, M&A/Private Equity, Corporate and Company Law
• Law Firm: Crawley MacKewn Brush LLP
• Author: M&A Risk Advisor, Kate McGrann and Joshua Shneer

This article is authored by Ragu Anantharajah at Wildeboer and Kate McGrann and Josh Shneer at our law firm

Purchase and sale agreements often contain restrictive covenants that limit a party's activities following the completion of the transaction. One common restrictive covenant is a non-competition and/or non-solicitation clause.

The purpose of these clauses is to protect a purchaser's interest in the business being acquired, by restricting the seller's ability to compete with or solicit employees or customers from that business. Such clauses often address the duration and scope of the restriction.

While a non-competition clause is a valid method of protecting a purchaser's interests, the restriction must be no more than what is reasonably necessary to protect those interests.¹

If a non-competition clause is found to be overly broad or unreasonable, a court may refuse to enforce it, or it may "notionally sever" and 'read down' the clause.² This means the court will interpret the unreasonable clause in a way that limits its intended effect.

A Battle of Interests

Parties to a sale may have competing interests regarding the seller's post-sale activities as they relate to the business sold. Non-competition clauses seek to balance those interests. When courts are asked to interpret these clauses, further interests are engaged; the parties' rights to freely contract, including agreeing to limitations on business activities, and the competing policy interest of maintaining free and open trade, which favours limiting restrictions on business activities.

Commercial vs. Employment Agreements

Courts approach restrictive covenants in commercial agreements differently than those in employment agreements. Courts are typically deferential to restrictive covenants in commercial agreements between contracting parties, and there is a presumption that a restrictive covenant is enforceable. The rationale is that in commercial agreements the parties are presumed to be on "equal footing", to have equal bargaining power, and there is a greater flow of consideration. Put another way, "[c]ompetently advised parties with equal bargaining strength, expertise, experience and access to resources are the best judges of what is reasonable as between them".³

In contrast, with respect to employment agreements there is a power imbalance that characterizes the relationship between an employee and employer. In fact, Ontario recently introduced a statutory prohibition on the inclusion of...