In Defense of Restrictive Covenants

March 2, 2018
By Noel Courage 

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” circumstances[1]. 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 that generated and owns the IP. When drafted with a reasonable, focused scope, restrictive covenants for key employees can be fair and justified to protect a company’s hard earned IP. Confidentiality and assignment of IP clauses should also always be in the original employment agreement. 

If the company has registered a patent for the IP, it may have some legal recourse against the departed employee and new employer if the technology is taken. Likewise, if trade secrets are misappropriated or if surviving confidentiality clauses from the terminated employment contract are breached, there may also be recourse. Both patent litigation and confidential information litigation are very expensive and complex. It is difficult to collect evidence to prove misappropriation of information since the only readily apparent evidence before litigation starts may be that another company hired one's employee and then its product development seemed to jump further along. It is also difficult to assess pre-litigation, what the other company may have known before it hired one’s employee and how and if the employee springboarded the research program.

If a reasonable scope of restrictive covenants could be enforced, the main issue to be proven in litigation would be the relatively distinct issue of whether the employee was performing the temporarily prohibited employment duties in the restricted time and geography. As one example where a narrow, focused restrictive covenant could have been useful and fair (likely none was used), the pharmaceutical company, Apotex many years ago developed a bacterial fermentation process in Manitoba to produce a very valuable heart drug called lovastatin. Determining the best chemical conditions for growing bacteria to produce large amounts of a drug can be a challenge. Apotex decided to keep its process secret, rather than filing patent applications. A departing scientist left to join a competitor, Novopharm (now Teva Canada), and used knowledge he obtained at Apotex to springboard the Novopharm fermentation process for lovastatin. To prove misappropriation of confidential information, Apotex:

1) Obtained an Anton Piller (search and seizure) order allowing it to search Novopharm offices to seize information, and

2) Had to prove that the information Novopharm used was Apotex’s confidential information. 

It can be a factually difficult task to demonstrate that one's company information was integrated into another company’s complex, ongoing research and development. It is not a small cost or effort to obtain a search and seizure order and then go into the detail of a court discovery process. Given the uncertainties and expense, most small companies would probably find it difficult to litigate to protect their IP in similar circumstances. 

Apotex apparently did not have a non-competition clause with the departing scientist, which is a common situation that we don’t criticize here. As a constructive suggestion, a potential non-competition clause could have been narrowly drafted to allow the scientist to use his general skills and knowledge for competitors but to prevent the employee from working on the exact same drug and process (i.e. lovastatin fermentation projects) for competitors. As a more aggressive approach, if the scientist worked on new projects for Apotex during employment, these projects could have been added to the restrictive covenant. To ensure consideration for the amendment to the employment agreement, it could be made at a time when the employee was receiving fresh consideration such as a discretionary pay increase, a bonus or extra time off. The author is not aware of this practice being used in the pharma industry. It would take some effort to initiate and manage. However, the cost-benefits and value of executing this type of restrictive covenant and employment agreement updating may be justified for key employees and very valuable IP. 

In summary, there appears to be a practical application for non-competition clauses in IP-intensive industries that rely on R&D for their competitive advantage. Different types of restrictions, such as non-solicit clauses, confidentiality clauses, and assignment of IP clauses, should also continue to be used for protection. Draft these clauses separately, so that clauses at risk of unenforceability may be readily severed. It remains to be determined whether courts will find that protection of IP, in some cases, falls within the exceptional circumstances where a well-drafted, reasonable non-competition clause would be enforceable. 

[1] H.L. Staebler Company Limited v. Allan, 2008 ONCA 576, involving commercial insurance, where the unenforceable clause stated, “you will not, for a period of 2 consecutive years following said termination, conduct business with any clients or customers of H.L. Staebler Company Limited that were handled or serviced by you at the date of your termination.” (No geographical limit). See also Mason v. Chem-Trend Limited Partnership, 2011 ONCA 344 involving a chemical company sales representative. Martin v. ConCreate USL Limited Partnership, 2013 ONCA 72 in the context of an employee and minority shareholder signing restrictive covenants in conjunction with a sale of a business.

[2] Elsley Estate v. J.G. Collins Insurance Agencies Ltd., [1978] 2 S.C.R. 916.

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