Price Tags on Competition are a Restraint of Trade: The Functional Approach to Permissive Non-Compete Clauses Prevails in British Columbia
In Rhebergen v. Creston Veterinary Clinic Ltd., 2014 BCCA 97, the British Columbia Court of Appeal granted the appeal of an employer veterinary clinic, Creston Veterinary Clinic (“CVC”), from a Supreme Court of British Columbia decision declaring unenforceable a contract clause requiring its employee, Dr. Stephanie Rhebergen, to pay CVC a prescribed amount in the event she was to compete with CVC within a certain period after the contract was terminated. Unlike conventional non-competition or non-solicitation clauses that constitute a restraint of trade, the clause before the BCCA contained no prohibition. Rather, the clause at issue was permissive in that Dr. Rhebergen could freely pursue a practice which competed with CVC, albeit burdened with a cost which she would not otherwise bear.
Dr. Rhebergen obtained a job with CVC prior to graduating and obtaining a licence to practice veterinary medicine. A great deal of CVC’s business was drawn from dairy farms in the Creston area.
She entered into an associate agreement with CVC which contained a “Non-competition” clause providing that if the contract was terminated and Dr. Rhebergen “set up a veterinary practice” in Creston, BC or within a 25 mile radius of CVC’s place of business in Creston, BC, Dr. Rhebergen would have to pay $150,000 (if the competing practice was set up within a year of termination), $120,000 (if it was opened within two years), and $90,000 (if it was opened within three years) (the “Clause”). The prescribed amounts represented CVC’s anticipated losses arising from Dr. Rhebergen’s departure, both in terms of investment in her training and loss of CVC’s business/clientele to her future workplace.
Differences arose between CVC and Dr. Rhebergen after 14 months of employment. She informed CVC she was terminating the agreement and would not continue to work for the clinic. The associate agreement did not provide Dr. Rhebergen with termination rights but permitted CVC to terminate for just cause. CVC informed Dr. Rheberghen she was precluded from terminating and then exercised its right to terminate her for cause.
Five months later, Dr. Rhebergen filed a notice of claim pleading she intended to “set up” a mobile dairy veterinary practice in Creston and the surrounding vicinity and seeking to have the Clause declared unenforceable.
The Trial Decision
The trial judge quickly concluded the impugned clause was a restraint of trade and focused his analysis on whether the Clause was unambiguous or a reasonable restraint, having regard to its temporal length, the spatial area covered, the nature of activities prohibited, and overall fairness.
The trial judge determined that the Clause was ambiguous and therefore unreasonable because the phrase “set up a veterinary practice” could mean a variety of things.
In considering the overall reasonableness of the restraint, the trial judge confirmed that while there was actually no prohibition on any activities, the Clause was effectively a non-competition clause aimed at protecting CVC’s clientele and that its reasonableness, in his view, would turn on whether the prescribed payment amounts represented liquidated damages or a penalty. The trial judge ultimately held the payments were a penalty in that they were somewhat arbitrary and relied in large part on Dr. Rhebergen’s salary which was not a valid component when assessing genuine pre-estimated damages, as CVC would not have to incur salary costs once the agreement was terminated. As a result, the trial judge found the amounts claimed excessive and the Clause unreasonable.
The trial judge took no issue with the spatial area covered by the Clause, as even Dr. Rhebergen acknowledged it was reasonable. The trial judge viewed the temporal length of the Clause as “too long” as it amounted to 2.5 times the length of Dr. Rhebergen’s time of employment at CVC.
The Decision: The Restraint was Unambiguous and Reasonable
The BCCA allowed the appeal. Lowry J.A. wrote a lengthy dissenting decision canvassing all issues. The majority (comprised of Smith J.A. and Benett J.A.) accepted Lowry J.A.'s reasoning on all issues except the issue of whether the Clause was unreasonably ambiguous. The majority held the Clause was not ambiguous and therefore allowed the appeal.
The BCCA unanimously agreed that the Clause was a restraint of trade. Lowry J.A. succinctly concluded:
While clause 11 is not a conventional non-competition clause in that it contains no prohibition, it is, as its title in the agreement suggests, a kind of non-competition clause because it effectively provides for no competition within the stipulated radius during a three-year period after the termination of the associate agreement in the absence of the required payment. The payment is a restraint – it compromises the opportunity to compete with the clinic Dr. Rhebergen would otherwise have.
The BCCA also unanimously agreed that the payments to be made by Dr. Rhebergen were not a penalty but rather compensation for the costs incurred by the clinic in training Dr. Rhebergen and which Dr. Rhebergen acknowledged were reasonable. The BCCA concluded the trial judge misapprehended the basis upon which the payments were calculated as he failed to appreciate the calculation was of Dr. Rhebergen’s salary. The BCCA determined that on the evidence, properly understood, it could not be said that the payments were extravagant or unconscionable.
Lowry J.A. did engage in an analysis of whether the nature of the payment was even relevant to the question of “reasonableness” or whether the prescribed payments at issue could even constitute a penalty (as they were dependant on the occurrence of a future discretionary event as opposed to termination). While his analysis seemed to endorse factoring the quantum of the payments into the “reasonableness” analysis, this was ultimately unnecessary as it was determined the trial judge erred in his own approach in any event.
The BCCA diverged on the issue of ambiguity. Lowry J.A. decided the phrase “set up a veterinary practice” was not definitive as it does not identify at what extent Dr. Rhebergen’s provision of veterinary services would trigger the compensation provisions.
The majority found no such ambiguity and found the intent of the parties could be objectively determined by construing the plain and ordinary meaning of the impugned phrase in the context of the agreement as a whole and the factual matrix in which the agreement was reached. The majority held it was evident the parties understood that “setting up” the proposed mobile dairy veterinary practice would be in breach of the Clause and that Dr. Rhebergen’s own pleadings and evidence made this abundantly clear. The majority noted the only dairy herds in the Creston Valley are situated within the 25-mile radius of Creston, are the CVC’s patients and clients, and were therefore the target of Dr. Rhebergen’s proposed mobile dairy practice. Dr. Rhebergen’s stated intention when commencing her action to “set up” a practice in order to compete with CVC confirmed the parties understanding.
Potential Significance: British Columbia Adopts the Functional Approach
The most significant aspect of the BCCA’s decision arises in Lowry J.A.’s initial inquiry of whether the Clause constitutes a “restraint of trade” in the first instance. As noted, the Clause differs from conventional non-competition or non-solicitation clauses that constitute a restraint of trade as it contains no prohibition. Unlike the prohibition that renders a more conventional clause a restraint of trade, the Clause at issue could be considered a restraint only because of the financial consequence it imposed on the employer’s future conduct. Lowry J.A. acknowledged.
Whether such a clause in a contract of employment amounts to a recognized restraint for the purposes of the doctrine, rendering the clause unenforceable if unreasonable, is, in my view, by no means settled law.
In determining whether the Clause was a restraint of trade, Lowry J.A. considered two strands of authority regarding clauses of a similar nature. The first is the ‘functional’ approach, which asks whether the clause at issue attempts to, or effectively does, restrain trade. The second is the ‘formalistic’ approach, in which the clause at issue must be structured as a prohibition against competition. Under the ‘formalistic’ approach, disincentives to post-employment competition are not sufficient to trigger the doctrine, even if those disincentives operate as effectively at dissuading competitive conduct as a prohibition.
The BCCA ultimately adopted the functional approach, concluding:
Here, against this background of conflicting authority, like the judge, I consider clause 11 of the associate agreement constitutes a restraint of trade. In my view, the functionalist approach established in English law is to be preferred as the legal basis for determining whether clauses that burden employees with financial consequences, whether by payment or forfeiture, they would not otherwise have for engaging in post-employment competition constitute a restraint on trade. In the words of Lord Wilberforce, it is a matter of the effect of the clause in practice over its form.
Authority stemming from Ontario appears to favour the formalistic approach; however, Lowry J.A., did note that a recent Ontario Superior Court decision, while acknowledging it was bound by a 1941 authority employing the formalist approach, appears to have endorsed the ‘functional’ approach, without adopting it outright. In light of the BCCA’s decision and the Ontario Superior Court’s recent endorsement of the functionalist approach, we may be seeing the commencement of a trend toward accepting the functional approach to determine whether permissive non-compete clauses are a restraint of trade. This area of the law is one to watch in Ontario and is suitable for consideration at the appellate level.
Rhebergen v. Creston Veterinary Clinic Ltd., 2014 BCCA 97
Date of Decision: March 12, 2014
British Columbia Court of Appeal non-competition clause