In the 2014 split decision of the British Columbia Court of Appeal in Rhebergen v. Creston Veterinary Clinic Ltd., 2014 BCCA 97, the majority of the court upheld the enforceability of an employment liquidated damages clause.

The decision is instructive not only in the employment context but also in franchise non-compete decisions where the standard of enforcement is less stringent.

Key Facts

The dispute arose between a veterinary clinic in the Creston, B.C., rural area, and a new veterinary associate who was employed by the clinic and later left to provide competing services through a mobile clinic.

The clinic and the associate entered into a three-year employment agreement. The agreement contained a form of a non-competition clause.  It did not directly restrict the associate’s competitive activities but instead imposed lump sum payments if the associate competed with the clinic within a 25-mile radius of the clinic in the Creston area.  The amounts of the liquidated damages were on a declining scale during the first, second, and third year of the competing activities.

There was no competing clinic in British Columbia within a 100-mile radius, i.e., well beyond the 25-mile radius in the agreement.  Many other clinics existed only much farther – within a 130-mile radius.  The clinic derived the bulk of its business from eight dairy farms located in the Creston area, all within the 25 mile radius.

The majority of the Court of Appeal, in a two-to-one split, reversed the trial decision and held that the clause, while in restraint of trade, was not ambiguous and was reasonable.

Whether the Clause was in Restraint of Trade

While the court acknowledged that the law was unsettled whether a liquidated damages clause in an employment contract amounts to a form of restraint of trade on the basis of the financial burden that it places on the employee, the court ruled unanimously that this was an obstacle to competition and, as such, was in restraint of trade.

In doing so, the court expressly adopted the “functional” English law approach by looking at the implied effect of the financial disincentive.  By requiring a significant payment, it effectively compromised the associate’s opportunity to compete with the clinic within the restricted radius.

This is in contrast to an established line of authorities in Ontario, starting with a seminal 1945 Ontario Court of Appeal decision inInglis v. The Great West Life Assurance Co., [1941] O.R. 305 (C.A.).  It adopted a stricter “formalist” approach, requiring an express prohibition against competition in order to be considered in restraint of trade.  Under the Ontario “formalist” approach, if a clause does not preclude a former employee from engaging in any competing activity, but merely imposes an agreed-upon financial cost or disincentive to the post-employment competition, it does not constitute a restraint of trade.

Whether the Clause Was Reasonable

The court diverged on whether the clause was ambiguous.

Under the accepted Canadian legal analysis of the enforceability of a clause in restraint of trade, the clause ought to be reasonable.  A key requirement in the reasonableness test is whether the clause is clear or ambiguous with respect to the nature of the restricted activity, or the spatial (territorial) or temporal (period of time) restrictions.

  • Whether the monetary amount amounted to liquidated damages or a penalty

The court unanimously agreed, based on a 1976 Supreme Court decision, that the reasonableness of the monetary amount, i.e., whether the lump sum payments set out in the clause amounted to a genuine estimate of anticipated damages or a penalty, was only relevant to the issue of damages; it was not relevant to the reasonableness of the clause itself.

Nevertheless, the minority opinion, which provided much of the analysis on this issue, and with which the majority opinion concurred, went on to analyse the reasonableness of the monetary amount.

The court found that the amounts were liquidated damages, rather than a penalty, based on trial evidence of the clinic’s principals.  The evidence was that the lump sum amounts were calculated based on the anticipated investment in training the new veterinarian associate, and the anticipated loss of goodwill and business if she were to compete for the clinic’s clients.  This evidence was not seriously challenged at trial, and the court found that the lump sum amounts were not extravagant or unconscionable.

  • Whether the competing activity was ambiguous

Ultimately, the court diverged on the meaning of the competing activity, and more specifically, the meaning of the words “set up practice”.

For the minority opinion, like the trial judge, these words were ambiguous.  For them, these words required that the former associate’s new clinic have a significant practice within the territory, as distinguished from merely “practising” which could mean a small presence in the area.  The dissenting opinion held that it was uncertain when an activity would cross the line from merely “practising” to “setting up practice” in the area.

The majority of the panel disagreed with this interpretation.  It held that there was no practical difference in the circumstances of this case between “practising” and “setting up practice”.

Relying on established contractual interpretation lines of authority with respect to the reasonable intent of the parties, the majority opinion concluded that the clause could not be said to be ambiguous merely because of a difference of opinion about whether a hypothetical activity would trigger the compensation obligation.

The clause need not be definitive in all imaginable circumstances.  For the majority, instead of looking at hypothetical scenarios that had no bearing on the reality of the dairy practice in the particular area of the clinic, the meaning of the words had to be clear in the context of the specific facts of this case.

It appears that the majority opinion essentially relied on the following key factors in upholding the validity of the clause:

  • The purpose of the provision. Another clause in the article of the agreement described the intention of the clause to discourage the associate veterinarian from using the advantages gained from her employment to compete with the clinic.  For the majority, this stated purpose must instruct the proper interpretation of the words “setting up practice”.
  • The ‘plain and ordinary meaning’ of these words implied continuous or regular delivery of professional services with a degree of permanency.
  • There were no established veterinary clinics within the 25-mile geographic limit in the clause, and even a much larger 100-mile area. Given the sparsely populated rural area the comprised the 25-mile radius, there was no practical difference between the words “set up in practice” and “to practise”: the associate doctor could not provide veterinary services in the area without in fact setting up her own practice.
  • The principal source of the clinic’s business was comprised of eight dairy farms, all of which were situated within the clause’s 25-mile radius. It did not matter where the practice was located, but rather were its services were being delivered (a point which in fact the dissenting opinion advanced).  As a result, the associate veterinarian’s proposed practice, even if mobile, would effectively target these very clients.
  • The manner in which the parties litigated the issue was instructive to the interpretation of the words in dispute. The associate veterinary’s pleadings in the action at trial did not raise the issue of ambiguity.  Rather, her focus was the unreasonableness of the clause in amounting to a restraint of trade.  Further, the associate doctor’s own affidavit materials referred to her having been encouraged by members of the community to “set up” her own clinic in the area – suggesting a common understanding of the meaning of these words.

As a result, the majority opinion determined that the clause, although in restraint of trade, was not ambiguous, was reasonable and, therefore, enforceable.

Critique

With respect to the court’s unanimous finding that the clause was in restraint of trade, it is respectfully submitted that the reasoning poses some difficulties.  The majority sided with the dissenting reasons on this issue, in applying the English functional approach.

It seems logically at odds to hold on the one hand that the financial disincentive amounts to a form of restraint of trade, yet on the other hand acknowledge that the amount of the financial disincentive was not determinative of the reasonableness of the restraint.

Granted, doing otherwise would create circular reasoning: the same element (financial disincentive) being used to both determine whether a clause was in restraint of trade and whether it was reasonable.

However, it is submitted that this is a circular reasoning that is genuinely inevitable.  It is logically impossible to separate the two elements in this legal framework: what if the lump sum amount were to be a nominal one hundred dollar.  Could it still be said that the clause amounts to a restraint of trade?

Unlike time and territory which are the elements of a genuine prohibition against competition, the monetary amount in financial disincentive cases is the pivotal reason for holding it to be in restraint of trade.  In other words, the amount of the financial disincentive – not the mere existence of any financial disincentive – drives the finding that the clause amounts to a restraint of trade.  It necessarily implies that the amount is unreasonable.

This creates a “chicken and egg” problem of what comes first.  The same factor – the amount – should not be used for analyzing both whether there is a restraint of trade and whether it is itself reasonable.  It is based on circular reasoning.

But to artificially remove the circular reasoning by ignoring this inevitable conclusion does not avoid the inherent contradiction.

If the monetary restriction is the very reason why the clause is considered in restraint of trade, how can this be reconciled with the established Canadian rule that it is otherwise irrelevant to the assessment of the reasonableness of the clause?

It is submitted that cases, as here, involving financial payments in lieu of competition do not easily lend themselves to the application of a conventional non-competition analysis since the key factor – the monetary amount – has to be implicitly used through circular reasoning.

Indeed, the dissenting opinion expressly resorted to the monetary amount on the issue of whether or not the clause was ambiguous: it held that given the significant monetary amount of $150,000, it could not be said that the words “to set up in practice” could be triggered if only a minor practice, say involving one client, was in issue.

This problem would appear to bode well for the formalist approach used in Ontario, which requires that the restraint of trade be explicit, rather than implying it on the basis of an economic disincentive.

However, with respect to the analysis of the unambiguous and reasonable nature of the clause, the majority opinion appears to offer a more practical, pragmatic and straightforward analysis in ultimately upholding its validity as an enforceable clause.

***

This article is provided for information purposes only. Law Works’ Franchise Law Blog does not provide legal advice.

For more information about Law Works’ expertise and how we may be able to help you, please contact Ben Hanuka at ben@lawworksdev.wpengine.com or by phone at (855) 978-5293.

Law Works Dispute Resolution Law Firm