Two Topics Relating To Restraint Of Trade In Employment: Practical Alternatives To Restrictive Covenants And The Impact Of Restrictive Covenants On Reasonable Notice

1. Practical Alternatives to Restrictive Covenants: Two Recent Cases

1. Introduction

   Given that it appears that restrictive covenants (at least in the employment context) usually aren't worth the paper they're written on, perhaps it's time that we lawyers get a little more creative and look for alternatives. Let's look at two cases where smart counsel (or perhaps their smart clients) did just that, with great success.

   1. Example #1: Levinsky v. The Toronto-Dominion Bank, 2013 ONSC 5657

      Facts

      Blair Levinsky started his career with TD Bank in 1999 after receiving his LLB/MBA. Apparently, one summer with a firm in Toronto was enough to convince him that the real money was not in law but in banking. And he was certainly right about that: within four years of joining TD, his annual compensation rose to more than $800,000.

      One part of the compensation program offered by TD was the Long Term Compensation Plan ("LTCP"). The plan changed somewhat over the course of Mr. Levinsky's tenure but in the last three years of his employment, the LTCP centered around the granting of Restrictive Share Units ("RSUs"). Each year, an employee would receive a certain number of RSUs (calculated on the employee's compensation) and those RSUs would mature into cash three years after being granted. However, in the event that the employee quit before the allocated RSUs matured, the employee would not receive any pay out for the RSUs.

      In 2010, Mr. Levinsky decided to start his own hedge fund and tendered his resignation to TD. He was therefore denied entitlement to the RSUs granted to him for the previous three years, the cash value of which was over $1.6 million. Not surprisingly, Mr. Levinsky decided to challenge TD. His clever argument was that the provision of the LTCP requiring forfeiture of the value of the RSUs was akin to a restrictive covenant, was unreasonable and thus unenforceable.

      It is apparent from the reasons for judgment that the court deemed it quite important that TD had been meticulous in consistently making it clear to employees that the RSUs did not mature until three years after granting. For example, TD provided a "Questions & Answers" sheet about the RSUs which made this clear and annual compensation statements also set out the requirements for payment. Proxy circulars had similar reminders about the maturity feature of the RSUs. Last but certainly not least, employees were required to sign a Participation Agreement (on an annual basis) which required the employees participating in the LTCP to agree to be bound by all the terms of the plan. Although Mr. Levinsky complained that he had no choice but to accept the terms, the court had little time for such argument, noting that Mr. Levinsky had certainly received the benefit of the plan and therefore was required to accept the burdens of the plan as well.

      However, it is worth noting that the forfeiture clause in the LTCP was not introduced until a few years after Mr. Levinsky became entitled to participate in the plan. He argued that the introduction of the forfeiture provision, without consideration, was made unilaterally and was unconscionable. The evidence, though, reflected that he had willingly accepted the terms of the Participation Agreement and made no complaint about the new provisions. He also accepted the cash payments he did receive when his RSUs matured. As a "sophisticated individual, trained in both law and business," the court found that Mr. Levinsky was not a "contracting party laboring under an imbalance of bargaining power" (¶44). Query whether an employee not as sophisticated (or well compensated) would have had more success with this argument. That being said, the fact that a significant benefit was received without complaint seems to have been the more persuasive factor from the court's perspective, so perhaps not.

      1. Restraint of Trade?

      The trial judge then turned to Mr. Levinsky's main argument: that the forfeiture provision constituted a restrictive covenant (and an unreasonable one at that). First, of course, Mr. Levinsky had to convince the court that the provision was in fact a restraint of trade.

      The court accepted that restraints of trade don't always look like traditional restrictive covenants:

      [50] Whether a particular provision operates in restraint of trade falls to be determined not merely by the form of the clause, but by the effect of the clause in practice. So, for example, where a clause on its face contained no direct covenant to abstain from any form of competition, but did require the former employee to share profits with his former employer on any new business written following his resignation, the clause operated to cause the employee to refuse business he otherwise would take, thereby constituting a restraint of trade.

      He then undertook an extensive review of the law (from both Canada and elsewhere) with respect to the impact of departure on future or deferred compensation. This review is summarized below:

   1. Termination and entitlement to future income

      Inglis v. The Great West Life Assurance Co., [1941] O.R. 305 (C.A.): the employment contract provided that the employee would continue to receive commissions on business written during the term of employment, despite termination, unless the employee became connected to or did work for any other life insurance company, in which case the commissions were forfeited. The Court of Appeal concluded that the clause was neither a restraint of trade nor a penalty.

      Woodward v. Stelco Inc., [1996] O.J. No. 1273 (Gen. Div.): the employment contract provided that the employee would receive an income stream in addition to the employee's pension so long as the employee did not, after retirement, engage in any activity that was in competition with the employer. The court found that the clause did not constitute a restraint of trade because it was not a benefit the employee was entitled to per se.

      Furlong v. Burns & Co. Ltd., [1964] 2 O.R. 3 (H.C.J.) (S.C.): a settlement agreement entered into after termination of employment required the employer to pay a monthly retirement allowance, subject to the employee not conducting himself in a manner detrimental to the employer. The court found that this was a restraint on trade and unreasonable.

      Wyatt v. Kreglinger, [1933] All ER Rep 349 (C.A.) (England): the employer granted the employee a retiring allowance upon termination, on the condition that the employee not work in the wool trade. The court found that the provision was an unreasonable restraint on trade. (The court in Levinsky was obviously not a fan of this decision, as can be seen at ¶60 of the reasons.)

   2. Termination and the claw-back of exercised stock options

      Nortel Networks Corp. v. Jarvis, [2002] O.J. No. 12 (S.C.): the terms of the employee's stock option grant stated that if the employee accepted employment with a competitor within 12 months of exercising any options, the employee was required to pay the employer any profits resulting from the exercise of the options. The court held that a contractual provision requiring an employee to forego a benefit as a result of competition was not a restraint of trade. While requiring the disgorgement of profits, the provision was akin to a penalty, but not an oppressive one.

      Tullett Prebon PLC v. BGC Brokers L.P., [2010] EWHC 484 (Q.B.) (England): the terms of the employment contract required the repayment of retention and...