In Defense Of Restrictive Covenants

Restrictive covenants are a tool sometimes used in employment contracts by innovative R&D companies. This type of clause typically prohibits a former employee from working for a competitor for a certain limited time and/or geography. The goal of the clause is to temporarily limit competition, and also reduce the risk that intellectual property (IP), such as trade secrets, will leave the company with the employee. Although this type of clause is also often used between sophisticated companies that are business or R&D partners, this article will focus on the employment context.

The pendulum may have swung too far against restrictive covenants. In an earlier article, I discussed how the Ontario Court of Appeal, had recently reinforced that restrictive covenants were valid and enforceable only in "exceptional" circumstances1. That is not an easy test to meet. The Supreme Court of Canada previously stated that an exceptional case may exist, for example, where it is reasonable to prohibit a former employee, "from establishing his own business or working for others so as to be likely to appropriate the employer's trade connection through his acquaintance with the employer's customers."2 A restrictive covenant will not be enforced where a non-solicit clause will be sufficient to protect a company's interest.

These court decisions, like in many other restrictive covenants cases, were made in the context of sales and/or conventional business issues, not in the context of the development of IP by a technology company. It is not known if protection of IP would be an "exceptional" circumstance if the effect fell short of effectively appropriating a business. In some cases, the appropriation of IP takes features of innovative products, such as software or a manufacturing process for a chemical composition, not taking sales of the business itself. For some start-up technology and biotech companies, non-solicit clauses are virtually useless as a fallback because these companies are in heavy R&D mode and often do not have customers. An early stage company's value is in its intellectual property. It takes a lot of money and time to develop IP. These companies are extremely vulnerable if a departing employee goes to a competitor and springboards the competitor's R&D program or products forward. In trying to preserve the departing employee's right to earn a living, the courts should be aware that misappropriation of IP can be a severe blow to the company...