Restrictive Covenants In The Sale Of A Business

Restrictive covenants, by their nature, are contrary to public policy and prima facie void. A restrictive covenant can be enforceable if it is reasonable as between the parties and in the public interest. Therefore, reasonableness of the clause is central to the determination of enforceability.

The Sale of Business Context

Canadian courts distinguish between covenants arising in the course of the sale of a business and those in an employer/employee context. While non-competition clauses are assumed to be unreasonable for being a restraint on trade in both contexts, a restrictive covenant that is imposed in the purchase and sale of a business is more likely to be upheld. In Martin v. ConCreate USL Limited Partnership ("Martin") 1, the court stated, in the context of the sale of a concrete construction business, that a restrictive covenant in the sale of a business is the "paradigm of a justifiable restraint on trade." As compared to the power imbalance that is inherent in employment contracts, the parties to a commercial contract are sophisticated and more likely to have equal bargaining power. There is significant value in upholding freedom of contract in such cases.

The courts are also more willing to uphold restrictive covenants in the sale of a business because they frequently involve a payment to the vendor for goodwill. In consideration for that payment, the inherent value of the business is intended to remain and reside with the purchaser. As stated by Dickson J. (as he then was) in Elsley v. J.G. Collins Insurance Agencies Ltd.,

A person seeking to sell his business might find himself with an unsaleable commodity if denied the right to assure the purchaser that he, the vendor, would not later enter into competition.2

Bargaining for a restrictive covenant can assist the parties in reaching a mutually beneficial agreement because it can give the purchaser some comfort that the business will be protected.

The Legal Test

In considering whether to uphold a restrictive covenant in the sale of a business, the courts consider reasonableness through an overall examination of the clause, the agreement in which it is found, and all of the surrounding circumstances. The courts will look at whether the restrictive covenant is fair given the geographic and temporal restrictions set out in the covenant. The legal test is as follows:

Does the party protected by the restrictive covenant have a proprietary interest entitled to protection? Are the...