Written By Talia Bregman and Gary Solway
Table of Contents
- Written Contracts
- Recent Legal Developments
- Termination Provisions
- Restrictive Covenants (Non-Competition and Non-Solicitation)
- Arbitration Clauses
- Practical Tips Moving Forward
- New Policy Requirements
It is common practice for technology companies to use standard form employment contracts for all staff.1 Often those contracts are precedents from some other source—a prior start up, or even the Internet. Or they may have been provided by a law firm providing legal advice a number of years ago.
Regardless of the source of the standard form, if it has not been updated in the last six months to reflect recent changes in the law, there is a very good chance that some of its key terms are no longer enforceable in Ontario.
Not only is this bad news for Ontario employers in running their businesses on a day-to-day basis, but it also can impact their ability to finance and sell their businesses. Investors (whether private or public) and potential acquirers are likely to identify these deficiencies in their diligence review process and that could impact the value of the business or require remediation efforts to be undertaken on an emergency and costly basis.
In this post, we discuss some key terms in employment contracts and employment practices that are likely in need of updating to address recent developments.
Although this post discusses these issues primarily from an Ontario law perspective and with technology companies in mind, these issues are certainly not unique to businesses operating in Ontario or to technology companies.
Importance of Written Contracts
We highly recommend the use of written employment contracts. Some employers resist them because they think it is awkward to start a relationship by delineating topics such as how the relationship will end. However, a written contract, whether a formal agreement or an offer letter, will provide certainty—to both parties—about the various terms that will govern the ongoing relationship and its termination. Without a written contract, the employment terms will be determined by the application of common law (judge made law) principles, which are vague and may give rise to uncertainty surrounding important issues, such as severance entitlements.2
Implementation and Maintenance of Enforceable Contracts
To implement a written employment contract properly, certain key steps must be followed in a certain order. First, an employee must receive valid consideration to enter the agreement.
At the time of hire, the consideration being given to an employee is the job itself. At the time of an amendment to, or replacement of, an existing agreement with additional or more burdensome obligations on the employee, the consideration issue is more complex. Once employment commences, the imposition of a new term, or the modification of an existing one, may be viewed as a promise being made by the employee without consideration. If the employee does not receive something in return, the new or modified term is not enforceable.
Accordingly, the best practice is to tie the imposition of a new or modified term3 after employment commences to a new benefit that is readily identifiable. For example, a salary increase, signing bonus, extra vacation or new grant of options. It must be something that the employee would not otherwise have necessarily received in the ordinary course.
Second, it is important that the employee sign and return the employment contract or amendment before actually starting work or before the amendment takes effect. Ideally, the employee should receive the new or amended contract at least a week before the date the employee is to start work or return the signed amendment. This will reduce the risk that the employee alleges the contract should be set aside because the employee was under duress (inappropriate pressure) at the time of signing.
Third, employers must stay up-to-date with recent court decisions and legislative changes and how those may impact their contracts. Changes in the law can result in unenforceable terms.
Recent Legal Developments
There are at least three terms in employment contracts that are likely in need of some updating following recent court decisions and legislative changes: (1) termination provisions; (2) restrictive covenants; and (3) arbitration clauses.
At common law, to terminate a non-union employee without cause, there is an obligation on the employer to give the employee either (1) "reasonable notice", or (2) pay instead of reasonable notice. This obligation arises in circumstances where an employer does not have "cause" to terminate and where there is no provision in an employment contract specifying the period of notice required, or specifying the duration of employment.
Common law "reasonable notice" typically exceeds statutory minimum notice periods prescribed by employment standards legislation (in Ontario, the Employment Standards Act, 2000). Common law notice generally ranges between one to 24 months' notice, or payment of all compensation during that notice period instead of providing notice. The amount of common law notice is based on factors such as the departing employee's age, length of service, character of employment and availability of similar opportunities. There is no set formula for calculating common law notice and it is a fact specific assessment. The general principles that apply are that the longer the employee's service, the older the employee is and the more senior the employee's role in the company, the longer the reasonable notice period.
Under employment standards legislation, the notice period is usually much shorter than common law notice and is based solely on length of employment (and in some circumstances, the number of employees being terminated).
In an attempt to limit exposure to successful claims for common law notice from departing employees, many employers use employment contracts with termination provisions specifying severance entitlements. Recent case law has reinforced the importance of regularly reviewing and updating these termination provisions.
For many employers in Ontario, the 2020 decision of Waksdale v Swegon North America Inc., 2020 ONCA 391 has rendered the termination provisions of their employment contracts unenforceable. The Court concluded that an otherwise enforceable termination "without cause" provision in an employee's employment contract was unenforceable because a separate "with cause" provision was unenforceable, even though the employee was not terminated "with cause" and the employee was offered more than his employment standards entitlements. The result was that the employee was entitled to the longer common law notice period determined by the Court.
Other court decisions have invalidated without cause termination provisions because they attempted to exclude, or failed to expressly address, the interconnection between employment standards entitlements that an employee is unconditionally entitled to receive in a without cause termination situation, even if the employer had complied with the obligation to provide those employment standards entitlements.
Unfortunately, it is not possible to stop litigation claims by a disgruntled former employee for common law notice compensation. Termination provisions have been and continue to be frequently challenged in courts across Canada. Nonetheless, a carefully drafted and legally compliant termination provision in an employment contract can still be enforceable, protect against successful claims and provide leverage in settlement negotiations. To achieve that outcome, recent case law has reinforced that termination provisions in existing standard form employment contacts should be immediately reviewed and then periodically reviewed thereafter.
Restrictive Covenants (Non-Competition and Non-Solicitation)
A restrictive covenant is a clause in an agreement between an employer and the employee that places restrictions on the employee's employment and post-employment activities. The scope placed on the employee's activities may vary. It may limit the employee's ability to work in or carry on a business activity that is competitive with the employer's business. It may also limit the employee's ability to solicit the business of one of the employer's clients/customers or suppliers or to seek to persuade one of the employer's employees to cease employment with the employer.
- Non-Competition Covenants
Sale of business exception. This applies when: (1) there is a sale or lease of a business or a part of a business; (2) immediately after the sale, the seller becomes an employee of the purchaser; and (3) as part of the sale, the purchaser and seller enter into an agreement that prohibits the seller from engaging in any activity that is in competition with the purchaser's business after the sale. Employees who are shareholders of a company and sell their shares in the context of a share sale are "sellers". The wording of this exception is vague and does not on its face apply to all corporate structures that could be used to implement the sale of a business. However, the principle seems clear—an employee who continues with the business can sign a non-competition agreement if the employee participated as a seller of the business.
Executive exception. This exception permits an employer to enter into a non-competition agreement with an employee in Ontario if the employee is an "executive", which is defined in Ontario's employment standards legislation to mean: chief executive officer, president, chief administrative officer, chief operating officer, chief financial officer, chief information officer, chief legal officer, chief human resources officer, chief corporate development officer or holds another chief executive position. At this time, it is unclear if this is an exhaustive list of executive positions, whether this exception is limited to those with "chief" in their title (except "president"), and whether the Ontario Ministry of Labour and the courts will conduct any substantive analysis of an employee's job to determine whether the employee appropriately falls under the executive exception. Nonetheless, this exception will greatly limit the utility to technology companies of non-competition covenants in employment agreements, especially with respect to key development staff.
- Non-Solicitation Covenants
- Suggestions for Drafting
Narrowly define (1) the description of a competitive business; and (2) the applicable time period for which the restriction will apply.
Limit the list of clients/customers the employee cannot solicit (e.g., if entering into a non-solicitation agreement, generally the provision should prohibit the employee from contacting clients/customers with whom the employee had contact while employed. It is rare that a provision prohibiting the employee from contacting all clients/customers of the employer would be upheld by a court. It is only when the employee has developed a special relationship with a client/customer that the employer is vulnerable to loss of that client/customer because of the relationship).
Include a clause outlining the purpose and rationale of requiring the employee to agree to the restrictions.
Draft non-solicitation provisions and other covenants as separate clauses so that if one is found to be unenforceable, it won't automatically eliminate the others.
Include a provision that if the employee breaches the non-solicitation or non-competition covenant, irreparable harm is presumed and the employee agrees that injunctive relief is just and appropriate.
Include a severability clause that permits a court to sever provisions of the contract that it determines to be unenforceable without terminating the whole contract (note that these provisions are not always upheld or implemented by courts).
A non-competition covenant in a contract is designed to prevent a current or former employee from becoming a competitor or bringing valuable "know-how" to a competitor. Because non-competition covenants are restraints on an individual's ability to work, Canadian courts are reluctant to enforce them for public policy reasons. The primary "public policy" reason is to enable a person to earn a living based on their skills.
Ontario recently expanded the restrictions on non-competition covenants. Effective October 25, 2021, it is illegal to include a non-competition covenant in an Ontario employee's employment contract or other agreement (and whether entered into before, during or after employment ends).4 While there are a couple of exceptions to this non-competition prohibition, for technology companies who regularly use non-competition restrictions with all of their key development employees, the result is that non-competition provisions in new employment agreements will no longer be effective for a wide swath of employees in Ontario.
The two exceptions are:
Non-competition agreements that were entered into before October 25, 2021, in Ontario are "grandfathered" (i.e., not caught by this new prohibition), but are still subject to challenge at common law (where there are significant challenges to enforceability and legal advice should be obtained). It is not yet known whether amendments can be made to these grandfathered agreements. Non-disclosure or non-solicitation covenants are permitted, so long as these covenants are not, in substance, non-competition agreements.
California is another jurisdiction that will not enforce non-competition covenants. This means that a former employee of a Canadian company subject to a non-compete who moves to California to work for a competitor will not be stopped by a California court from working for that competitor even if it is a breach of the employee's non-competition covenant. Given the importance of Silicon Valley and San Francisco in the technology world, this is another very important limitation on the utility of non-competition covenants with no recourse. The former employer may be able to obtain some relief from Ontario courts against the California-bound former employee for the breach of a valid non-competition covenant, but if that judgment requires enforcement in California to be useful, then the former employer will be out of luck.
Non-solicitation covenants tend to be more focused and less restrictive than non-competition covenants. A non-solicitation covenant restricts the ability of a current or former employee to take personal advantage of the employee's connections with an employer's clients/customers, suppliers and other employees, for competitive or damaging purposes.
A non-solicitation covenant is most effective where an employee's principal duty is to act as a personal connection between the employer and its business contacts. For example, a non-solicitation covenant would provide protection for an employer who was concerned that a departing salesperson might bring clients/customers to a competing business. Note that this provision is usually drafted as a "non-solicitation", meaning that the former employee cannot solicit. It does not prevent clients/customers from following the former employee of their own accord. A clause that prohibits a former employee from having any business dealings with clients/customers who contact the employee of their own accord may be more akin to a non-compete than a non-solicit and therefore be void in light of Ontario's recent ban on non-competes.
A non-solicitation covenant would also provide some protection from the departure of one employee causing the departure of the employee's direct reports or friends. Of course, a non-solicitation covenant alone may not prevent employees from following a fellow co-worker if the employees initiated the move themselves. In that case, a restriction on hiring those employees would be more appropriate than a mere non-solicitation covenant (but also more difficult to enforce for public policy reasons).
Given the recent non-competition covenant ban in Ontario contracts with employees, Ontario employers should pay extra attention to their non-solicitation and confidentiality covenants to protect their confidential information and proprietary interests.
When drafting restrictive covenants, it is not a "one size fits all" situation. What is appropriate for one employee or business may not be appropriate for another. But, generally speaking, all restrictive covenants must be reasonable, should be tailored to an employee's role and responsibilities, only used where necessary and should be clear and unambiguous.
The following are some suggestions for increasing the likelihood that non-solicitation covenants will be enforceable:
One of the key aspects of non-competition covenants is to prohibit an employer's competitors from acquiring its confidential information through the employment of its former employees. If non-competition agreements can't be used for that purpose, it is important to ensure that employees and former employees are bound by enforceable confidentiality obligations. Employees cannot be stopped from using their core knowledge—for example, an engineer can't be stopped from using pure engineering knowledge. However, the engineer can be stopped from using knowledge of the former employer's products to the advantage of a new employer. Courts have upheld restrictions on the type of employment that a former employee can take on with a new employer to prevent the disclosure of confidential information (for example precluding the former employer from working on a competing product with the new employer where it would be impossible to do so without using the former employer's confidential information). So it is important to ensure that the confidentiality obligations are properly set out in the employment contract or other agreements with the employee.
An arbitration clause is a clause in a contract that requires any disputes between parties to be decided by an arbitrator rather than a court.
Arbitration clauses are not as common in employment contracts in Canada as they are in other jurisdictions, such as the United States. Some of the reasons are: (1) the "loser pays" costs system in Canadian courts; (2) a lower risk of punitive damages awards in Canada; and (3) a lower risk of a jury trial in Canada. However, if a key concern is keeping employment-related disputes largely out of the public domain and settling matters as expeditiously and confidentially as possible, then arbitration may very well be the preferred approach.
If a decision is made to include an arbitration clause in an employment contract, recent case law in Canada has indicated that these clauses must be drafted thoughtfully.
For example, the Supreme Court of Canada recently ruled in Uber Technologies Inc. v. Heller, 2020 SCC 16, that an arbitration clause was oppressive and thus invalid. The clause bound a worker living and working in Ontario to arbitration in the Netherlands and required the worker to a pay a hefty upfront administrative fee to begin arbitration, in addition to the legal fees, travel costs and lost wages the worker would inevitably face. The practical takeaways from the Supreme Court's decision (and a lower court decision in that case) for employment contracts are that: (1) the location of the arbitration should be the jurisdiction in which an employee works; (2) the employer should pay all, or a larger portion, of the fees associated with the arbitration; and (3) the arbitration provision should allow an employee to access statutory employment-related dispute resolution mechanisms (e.g., permit an employee to make a complaint to the Ministry of Labour for a violation of minimum employment standards).
Practical Tips Moving Forward
Following the recent court decisions and legislative changes in Ontario, employees now have many tools at their disposal to defeat and set aside employer-friendly contractual terms in their employment contracts. As a result, Ontario employers should review and update their employment contracts to consider the following on a go-forward basis:
- For businesses that are national in scope, consider maintaining a separate template for Ontario employees versus a national template for all employees to account for the unique Ontario requirements (e.g., the recent ban on non-competes).
- Add a severability clause to all contracts (even if not always upheld by the courts) to permit a court to remove provisions of the contract that it determines to be unenforceable without terminating the entire contract or the other aspects of the restrictive covenant that are enforceable.
- Include "savings" language providing that the contract will be subject to compliance with employment standards minimum obligations at all times.
- Regularly review and update standard form contracts at least on an annual basis.
- Address "lack of consideration" and other enforceability concerns in existing employment contracts by using new incentives such as a pay increase, promotion, signing bonus or some other entitlement the employee would not otherwise have received, as an opportunity to encourage employees to sign updated employment contracts.
New Policy Requirements
Although not necessarily requiring updates to employment contracts, there are two other recent legislative changes in Ontario for employers to be mindful of.
Companies that employ 25 or more employees in Ontario must implement a written policy on disconnecting from work. The policy must outline the company's expectations on disconnecting from work. Outside of that there is no requirement that the policy actually permit employees to disconnect from work, other than the limits on working hours that are already in place under Ontario's employment standards legislation.
Second, companies with 25 or more employees in Ontario need to have an "electronic monitoring" policy by the fall of 2022. This new policy requirement is intended to protect workers' privacy by requiring companies to be transparent about how they track employees' use of electronic devices (such as computers and cellphones). The policy does not need to limit a company's ability to monitor its employees or use the information it obtains through monitoring. The focus of this new policy requirement seems to be about being transparent about a company's monitoring practices as opposed to granting employees new substantive rights.
For technology companies who are unlikely to have a 9 a.m. to 5 p.m. workday and are likely to have electronic monitory systems in place, any disconnecting from work policy and electronic monitory policy should be carefully drafted and tailored to the nature of the company's business and needs.
How Bennett Jones Can Help
The Bennett Jones Technology, Media and Entertainment group focuses on all aspects of corporate law for businesses in the technology, media and entertainment fields. Please contact the authors or a member of the Technology, Media and Entertainment group for more information on the issues discussed in this post.
1 Start-up technology companies frequently engage staff as independent contractors for a variety of reasons, which include that the company is not obliged to make withholdings from contractors for taxes and other government payments (such as Employment Insurance premiums and Canada Pension Plan contributions). There are risks in treating staff as contractors rather than employees, particularly with respect to tax liability and intellectual property ownership -that issue is beyond the scope of this post.
2 For technology-based companies, it is important to have an employee who will be creating intellectual property enter into a proprietary information and inventions assignment agreement. In some cases, these are contained in the employment agreement, or as schedule to it. In other cases, they can be separate standalone agreements. They can also include confidentiality clauses and restrictive covenants such as non-competition and non-solicitation covenants. Wherever these terms are situated, the same rules apply in respect of employees (e.g., valid consideration must be provided to the employee, the employee must agree to the terms before they take effect, the terms should be reviewed periodically to ensure they are up-to-date, etc.) and these terms should be viewed as part of the employment relationship.
4 Ontario's new non-competition prohibition may not apply to non-competition covenants in shareholders agreements when entered into by an employee in their capacity as a shareholder of a company. Legal advice should be obtained in respect of the specific circumstances