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Jan

19

Associate Agreements for Dentists (Part 3): Restrictive Covenants

Toronto dental lawyer Michael Carabash

Associate Agreements for Dentists

Please note that the information provided herein is not legal advice and is provided for informational and educational purposes only. If you need legal advice, you should seek professional assistance (e.g. make a post on Dynamic Legal Forms). We have Toronto, Ottawa, Hamilton, Mississauga, Brampton, and other Ontario business lawyers registered on the website who can answer your questions or help you. I should know – I’m one of them and you can contact me directly (michael@carabashlaw.com).

So we’re still on the topic of associate agreements. In the first blog, I talked about how they play a role in virtually every dental practice – regardless of how it is legally structured. In my second blog, I talked about some of the differences between having the associate as an “employee” vs. an “independent contractor”. In this blog, I’ll be discussing restrictive covenants in associate agreements.

Restrictive Covenants

What the heck are restrictive covenants? These are provisions found in the associate agreement that restrict or prohibit the dentist from either competing with or soliciting employees or clients of the dental practice for a set period of time and within a specific geography after leaving or being terminated. Those provisions that deal with not competing in the same business as the dental practice as called non-compete agreements. Those provisions that deal with not soliciting the clients and employees of the dental practice are called non-solicitation agreements.

A big question that often comes up is: are these clauses enforceable. The answer is, as it usually is: it depends. It depends on whether they are reasonable. It must be reasonable as between the parties themselves and in light of the public interest. What is reasonable will depend on the circumstances.

Reasonablness of Duration of Non-Compete

For starters, courts will look at the reasonableness of the duration of the non-compete. This will depend on the facts of the case, but the cases suggest that courts are more willing to uphold longer non-competes in the non-employment context (e.g. buying and selling a business) than in the employment context.

Reasonableness as to Geographic Limit of Non-Compete

Courts will look at the reasonable expectation of the parties when they enter into the agreement. What is reasonable will depend on the circumstances AT THAT TIME. Geographic limits that are excessive may not be enforceable (e.g. province or country-wide). In Carnaghan Insurance Ltd. v. Lundy, (1974) 9 N.B.R. (2d) 651 (Q.B.), the court found that a non-compete which restricted competition for a 3 year period following termination of employment within the province of New Brunswick was unenforceable because the employer’s business was concentrated around Saint John. Here’s what the court wrote:

19 However the plaintiff has not satisfied me that the area covered by the agreement, i.e. the Province of New Brunswick, was reasonable. The business of the plaintiff was concentrated in the Saint John area. While there was no evidence adduced I think I can note that in a geographical sense the Saint John area is a minimal fraction of the province while from the point of view of population it represents about one-sixth of the province. In view of the fact that the plaintiff does not do any substantial amount of business in the rest of the province the agreement was, as regards area, unreasonable and excessive.

Furthermore, in an old Manitoba Court of Appeal case (New Method Cleaners & Launderers Ltd. v. Hartley, [1939] 1 D.L.R. 711 (Man C.A.), an employee agreed to a restrictive covenant which prevented him from soliciting dry cleaning or laundry business within Manitoba for a period of 1 year. But the employer’s business was primarily located in the City of Winnipeg, not the entire province. As such, the Court ruled the restrictive covenant was not reasonable in its geographic scope:

11 The plaintiff’s business, it has been seen, is in the city of Winnipeg and neighbourhood. The protection they were entitled to was with respect to route No. 1, and possibly the area within which they do business. A covenant in the circumstances which extends to the whole province necessarily is bad in toto. It is also invalid because within its scope are customers the defendant did not have business with, and persons with respect to whom he might or could have no knowledge that they were customers of the plaintiff, including customers obtained by the plaintiff after the termination of his service.

Finally, in Steele v. Ingram [2009] O.J. No. 3665, Steele sold his 50% interest in an insurance brokerage and, as part of that transaction, entered into an employment agreement which contained a non-compete clause. That non-compete clause required Steele to continue working for the insurance brokerage for 2 years after the sale and then not compete with the brokerage for a period of 5 years in Canada and the U.S. after the termination of his employment. When he was terminated, he went to work with another insurance company in Cambridge, Ontario. The brokerage refused to pay the outstanding purchase price on the basis that Steele breached the non-compete; the matter ultimately went to court.

The Ontario Superior Court of Justice held that it was not reasonable for the parties to assume or expect that the business sold by Steele would expand into all of Ontario, into all provinces of the country and into the United States of America. In short, the reasonable expectations of the parties as to the future scope of the business did not support a geographic restriction as wide as that contained in the Non-Competition Agreement. Now, worth mentioning is that the purchasers of Steele’s interest tried arguing that the advent of the Internet defined the parties expectations about being able to expand throughout all of Canada and the United States. The Superior Court rejected that argument on the basis that that company was regionally based in Guelph, Kitchener and Waterloo, and sold products identical or similar to those available to the public all over the world through countless other brokers. Besides, any business with a product to sell could theoretically purport to have a worldwide market because of the Internet; as such, the Internet could not as a general rule inform reasonableness for purposes of determining the validity of a non-competition agreement.

Reasonableness as to Activities

Assuming that a restrictive covenant is reasonable with respect to duration and geographic scope, there’s still the issue of whether the nature of the activities sought to be restricted are reasonable.

In certain circumstances, a Court may say that a non-solicitation agreement was sufficient and that a non-compete was too onerous and not reasonable. The case of Lyons v. Multari (2000), 3 C.C.E.L. (3d) 34 becomes relevant here. This is a leading case by the Ontario Court of Appeal concerning an employee dentist who was sued for allegedly breaching a non-compete clause in an employment contract. The issue before the court was whether that restrictive covenant was enforceable. The facts of that case are straightforward. One dentist was a principal of the business (i.e. the employer). Another dentist was an associate (i.e. employee). The two dentists signed a short-hand note that limited the associate’s ability to practice dentistry if he chose to leave. The entire non-compete clause said: “Protective Covenant. 3 yrs. – 5 mi.” After 17 months of working, the associate dentist left and opened up his practice – which competed with his employer’s business and was 3.7 miles away. The employer sued for breach of contract. The Ontario Court of Appeal disagreed, holding that the non-compete clause was unenforceable.

So how did the Court of Appeal end up there? Well, it started off by saying that all restrictive covenants go against public policy (free trade, etc.) and are therefore VOID. The only exception to this general rule is if the restraint is reasonable in the interests of the parties and also reasonable in the public interest. So there are a few factors which a court should consider to answer these questions: (1) whether the employer has a proprietary interest entitled to protection, (2) whether the temporal or spatial features of the clause are too broad, and (3) whether the covenant is unenforceable as being against competition generally, and not limited to proscribing solicitation of clients of the former employee. So with this test and factors in hand, the Ontario Court of Appeal held the following:

  • The employer had NO proprietary interest in other dentists who referred clients (so those referring dentists were up for grabs);
  • The employer benefited from the relationship with the employee;
  • The role played by the employee was not special; and

A non-solicitation clause would have sufficed (a non-compete clause was too drastic).

Overall, based on all of these factors, the Court of Appeal concluded:

48 For all of these reasons, I conclude that Dr. Lyons’ non-competition clause is unenforceable. His legitimate interest in protecting his own referring dentists and patients could have been protected by a non-solicitation clause. An established professional person or firm — be it in the field of dentistry, medicine, engineering, architecture, law or other professions — will constantly seek to recruit entry level associates to the practice. Such recruitment is good for the established person or firm and for the young associate.

In some situations, however, a non-solicitation clause will not suffice. Take the case of Elsey v. J.G. Collins Insurance Agencies Ltd., [1978] 2 S.C.R. 916. There, the Supreme Court of Canada was faced with the issue of whether an insurance agent had violated a non-compete clause in an employment contract with his former employee. The clause provided that the employee would not directly or indirectly engage in the business of a general insurance agent within the defined area for a period of 5 years after any termination of his employment as manager. The employee worked a number of years for the employer. During that time, he dealt with customers, gained knowledge of the insurable assets, financial credit, likes and dislikes and idiosyncrasies of each customer, in a recurring and confidential relationship. Then, one day, the employee left and started his own general insurance agency. He took 3 employees with him. He advertised and his former employer’s clients left to become his clients. The Court found that the non-compete clause was reasonable in duration, geographic scope and in light of the public interest. But would a simple non-solicitation clause have sufficed instead of a general non-compete? The Court didn’t think it would have been enough: where the employee has acquired a close personal acquaintance with the customers of the business, a covenant which prevents the employee from establishing his own business may be justified as opposed to a covenant which merely prohibits the solicitation of former clients by the employee. A non-solicitation covenant would not have been adequate to protect the plaintiff’s proprietary interest in its clients in this case. For these reasons, the Court found the non-compete enforceable and the employee liable for its breach.

Reasonableness as to Public Interest

The final element of reasonableness has to do with the public interest: if there an overriding interest (e.g. free trade, competition, etc.) which would a non-compete or non-solicitation clause unreasonable and therefore unenforceable? If, for example, there was insufficient labour or a shortage of competition in a particular industry, a non-compete or non-solicitation clause may be unreasonable. Using a non-compete clause to systematically eliminate competition will also be unreasonable.

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