Non-competition Clauses: Iron Shackles or Paper Tigers?
By Paul Martin
We are routinely consulted by newly graduated dentists concerning their first associate agreement. Their number-one concern is invariably the non-competition clause contained in the agreement. A non-competition covenant attempts to restrict the associate from working within a defined zone surrounding the Principal’s business, for a defined period of time, after the termination of the relationship with the principal. Understandably, new dentists are often apprehensive about signing an agreement with a Principal that restricts them from practicing in any way in the event the relationship fails.
We are also frequently contacted by Principal dentists with concerns that a former associate is in breach of the non-competition clause contained in their associate agreement. The Principal, wanting to protect their business at all costs, is often disappointed in the advice we give them concerning the enforceability of the non-competition clause.
The title of this post alludes to the difference that exists between perception and practice when it comes to the enforceability of non-competition clauses. On the one hand, Principals often believe that in having non-competition clauses in place, they are absolutely protected from possible attempts to compete by former associates (in other words, the associates are bound by iron shackles). On the other hand, in practice, courts routinely disregard the intentions of contracting parties, and will find ways to defeat restrictive covenants contained in otherwise binding agreements (rendering the clause a paper tiger – a clause that has teeth, but only on paper).
Non-competition clauses represent a drastic, and comprehensive, approach in attempting to protect business interests. Unfortunately, it is this very expansiveness that often leads to the courts deeming non-competition clauses invalid.
A typical example of a non-competition clause is as follows:
The associate shall not, either individually, or in partnership, or in conjunction with any other person or persons, corporation, partnership, syndicate, firm, association or any other entity, as an employee, Principal, agent, shareholder, officer, director or any other capacity whatsoever, directly or indirectly carry on or be engaged in or concerned with or interested in or advance, lend money to, guarantee the debts or obligations of, or permit his name to be used or employed by any person or persons, corporation, partnership, syndicate, firm, association or any other entity engaged in or concerned with or interested in the practice of dentistry:
- within a 3 KM radius of the practice during the term of this agreement; and
- within a 3 KM radius of the practice for a period of 36 months following the termination of this agreement.
Part (i) of the non-competition clause prohibits the associate from working within a 3 KM radius during the term of the agreement. Of note, clauses prohibiting competition during the course of the relationship are almost always deemed valid. The enforceability of non-competition clauses during the term of the relationship are viewed through a different set of lenses than non-competition clauses pertaining to post-contractual obligations.
We are noticing that there is a tightening in the market for full-time associates. This leads to a situation where many associates are working at two separate offices. Principals want to ensure that an associate does not work 3 days a week at their practice, and 2 days a week across the street. The potential harm this creates is that if patients begin to build a rapport with an associate at one practice, but are only available to see the associate on days they are scheduled at the other practice, then it will be of no concern to the patient if they go to one side of the street or the other. The law is clear that during the term of the agreement, associates owe duties of good faith and fidelity to their Principals. It is therefore deemed reasonable to impose a non-competition clause on an associate during the term of the agreement.
However, it is part (ii) of the clause that represents a challenge to Principals, and is often the source of much confusion and debate. The second part of the clause prohibits the employee or associate from working within a 3 km radius (known as the “spatial” or “geographical” aspect of the clause) for a period of 36 months (known as the “temporal” or “timing” aspect of the clause) after the termination of the agreement.
As a general proposition, and the default position typically taken by the Courts, clauses prohibiting competition after the termination of an agreement are enforceable only in “exceptional circumstances”, as they represent an unreasonable restraint on trade, which typically cannot be justified. The rationale being that competition is healthy for the marketplace, and individuals who have chosen a given career path should be able to pursue that career in the geographical area of their choosing.
The authoritative case dealing with the enforceability of non-competition clauses in the dentistry context is Lyons v. Multari, an Ontario Court of Appeal case. In Lyons v. Multari, the Court of Appeal enunciated the test to be applied when determining whether or not a non-competition clause should be upheld. Lyons was a case involving two oral surgeons in Windsor: Lyons, the Principal; and his Associate, Multari. Lyons had practiced in Windsor for 25 years. As with most oral surgeons, the source of Lyons’ patient base was referrals from GP Dentists. When he hired Multari, he implemented a rudimentary non-competition clause, which stated: “Protective Covenant. 3 yrs. –5 mi”. It is safe to say that Lyons did not have the assistance of legal counsel when he drafted the clause. Nevertheless, it was not the rudimentary nature of the clause that was its ultimate undoing.
Multari left the practice after only 17 months, and, 6 months later, set up his own practice 3.6 miles away. On its face, this action was a clear violation of the non-competition clause. Lyons sued for breach of contract. At trial, Lyons was successful and awarded damages in the amount of $70,000.00. The court held that Lyons had a proprietary interest in his referral base, which he had built up over time, and which was deserving of protection through a non-competition clause. Multari appealed the decision of the trial court.
The Court of Appeal summarized the relevant law and confirmed the following three-step analysis to be used in determining the validity of a non-competition clause:
- Whether there is a proprietary (ownership) interest worthy of protection. The courts will not enforce non-competition clauses where the intention is simply to prevent a former associate from competing in the dental industry generally. The necessary proprietary interest in the dental context relates to the relationship between the Principal and his or her patients (the goodwill of the practice). In dentistry, there will almost always be a proprietary interest worthy of protection, whether it is an existing patient base, or a referral source. Hence, this first aspect of the analysis will almost always be satisfied in the dentistry context.
- Whether the spatial (geographical) and temporal (time) aspects of the clause are reasonable. For instance, a dentist practicing in London, ON could not preclude a departing associate from practicing in “all of Ontario”, as this would be unreasonable. When looking at the reasonableness of the spatial scope, the size of the municipality, and the number of practices contained within the proposed zone, will be relevant. What is reasonable in a small town with 5 dentists, will not be reasonable in downtown Toronto. Generally, the larger the city, the smaller the geographical aspect of the clause should be. Similarly, the temporal aspect cannot be too long. A clause prohibiting competition for 10 years would almost definitely fail. Typically, these clauses should be kept to a maximum of 3 years. The shorter, the more reasonable.
- Whether, instead of the non-competition clause, a non-solicitation clause would adequately protect the employer’s interests. Assuming that there is a proprietary interest worthy of protection, and the clause has been drafted reasonably in terms of the spatial and temporal aspects, the Court will then examine whether a non-solicitation clause is sufficient to protect the legitimate proprietary interest. In most cases, this is the factor that defeats the use of otherwise reasonably drafted non-competition clauses.
A non-solicitation covenant permits competition to a degree, but narrowly precludes a former associate from competing by soliciting business from or through the patients of the other Principal. Simply put, the non-solicitation clause allows competition, but controls the manner of the competition.
In Lyons, the Court of Appeal agreed with the Trial Judge that the referral base of Dr. Lyon’s was a proprietary interest worth protecting. The Court of Appeal also held that in terms of the spatial (5 miles) and temporal (3 years) aspects, the clause was reasonable. As with most cases, it was on the third element of the test that the clause failed. The Court of Appeal confirmed that only in “exceptional circumstances” will the nature of the employment justify a covenant prohibiting the employee not only from soliciting the Principal’s patients, but also from establishing a competing business.
In such circumstances, a Court will examine the exact nature of the interest that requires protection, and determine whether it can adequately be protected by a non-solicitation clause. In this case, the Court held that Dr. Lyon’s existing referral base could be protected by prohibiting Dr. Multari from soliciting from the existing referral dentists. Of interest, the Court noted that Dr. Lyons did not have a proprietary interest in all possible referring dentists within 5 miles of his office, and that Dr. Multari could not be stopped from competing for business from potential referral sources within the 5 mile zone, as this would constitute an unreasonable restraint on trade.
I expect in the course of reading this post, the reader has at some point asked: “Wait, if these clauses are generally unenforceable, then why do I always them in associate agreements?”
Notwithstanding the general prohibition on non-competition clauses, our advice is typically to add these clauses to associate agreements. The rationale for doing so has nothing to do with the law, and everything to do with human nature. A significant percentage of the population is moral and law-abiding. Most people do not wish to breach contracts, especially with colleagues, in a relatively close-knit industry. Nobody wants to burn bridges. Even fewer wish to be on the defending side of a lawsuit. If a non-competition clause is inserted in an associate agreement, then a large percentage of departing dentists will look at it, and abide by it. In this way, notwithstanding the likelihood that the clause is unenforceable, it nevertheless accomplishes the intended goal. Further, the facts of a particular case may support the upholding of the non-compete, as it may be the only true way to protect a proprietary interest. If the clause was left out of the agreement because it is generally unenforceable, then the former Principal will not be able to try and enforce it at all. It is better to have the clause in the agreement, and allow the associate to argue unenforceability, then to not be able to have the argument at all.
If you wish to have an associate agreement drafted, or have an associate agreement you wish to have reviewed, please contact Matthew Wilton at email@example.com, or Paul Martin at firstname.lastname@example.org, or by phone at 416.860.9889.
*The foregoing is not intended to be legal advice and is provided for educational purposes only. You should retain a lawyer to seek advice prior to taking any legal steps.