How much firepower does an employer need to prevent staff from jumping to rivals and taking valuable intellectual property with them?
Employment lawyers in Canada are growing alarmed at the spread of sweeping provisions known as non-compete clauses in contracts for even low-level employees. These provisions are sometimes used as a weapon to intimidate workers into staying put or stalling their next career move.
The clauses ban an employee from joining competing companies for a specified period, often as long as a year, and in a specified geographic area, which could be all of North America. What most employees don’t know is that when challenged in Canadian courts, judges usually toss out non-compete clauses, saying they are too broad. But many large companies, particularly in the talent-hungry tech sector, are deploying them anyway, then sending threatening letters to employees who dare to leave and even taking some to court.
The clauses, letters and lawsuits send a clear warning. “The fear of being tied up in expensive litigation has a chilling effect, not just for employees, but also for prospective employers,” says Matthew Certosimo, a partner with Borden Ladner Gervais LLP (BLG) in Toronto.
In one recent case that made it to court, Dan Wright, a software developer in Toronto, had to wage a year-long legal battle to fend off his former employer, U.S.-based HR software conglomerate Ceridian HCM, Inc.
In 2016, after five years with Ceridian Dayforce Inc., Mr. Wright felt burnt out at the age of 32 and started looking for another job. “On many days, I felt like I had nothing left emotionally to give my family at the end of my day,” he said later in a court affidavit. “Because my wife and I had just welcomed our first child into the world, I did not want her to grow up with a father that was miserable and stressed out all the time.”
Mr. Wright interviewed with a few companies and eventually landed a position with Ultimate Software Group of Canada, a rival U.S.-owned firm.
When he told Ceridian he planned to leave, Mr. Wright said, a senior leader told him the company would “put the fear of God in me.” Then Ceridian sued Mr. Wright and Ultimate, claiming he had breached the terms of a non-compete clause included in an employment agreement he signed in 2011.
In late 2017, a judge of the Ontario Superior Court of Justice in Toronto ruled that the non-compete clause was unreasonable and unenforceable. Mr. Wright kept his job at Ultimate, but it was a tough fight – the court filings in the case now fill two bankers’ boxes in the basement of a Toronto courthouse. (Mr. Wright declined to give an interview for this story.)
In a written statement to The Globe and Mail, Ceridian defended its decision to go to court. “In exceptional cases like this one, where an employee has deep knowledge of commercially-sensitive intellectual property and confidential information developed at great expense by Ceridian, we seek to enforce non-compete agreements in order to protect ourselves from the potential for a serious breach of our trade secrets to our competitors. This is aligned with industry practices,” the company said.
Other employers make the same argument: Non-competes are necessary to encourage investments in worker training and research and development.
But in addition to the issues of basic fairness and protecting intellectual property, there is growing debate about the broader economic impact of the clauses. Some point to the United States, where California banned non-compete clauses more than a century ago; economists have argued the free movement of talented tech workers contributed to the rise of an extraordinary innovation economy based in Silicon Valley. In 2016, the Obama White House urged lawmakers in other states to follow California’s example and curtail the use of non-competes.
But in Canada, many large employers are hanging onto the clauses tenaciously.
"If these things are unenforceable, why are they being used routinely? Companies are using something they know is not enforceable to try to intimidate or deter people from certain behaviours,” says Michael Wright, a veteran employment lawyer who recently started his own practice working only for employees.
“It’s a power game, it’s an intimidation game,” he says. “[Employers] say, ‘Maybe people won’t inform themselves, so we can still get away with this.’ ”
There are no hard numbers on how many employees in Canada are subject to non-compete clauses, but employment lawyers say they are spreading, particularly in the tech sector, and they find that disturbing. “I’m noticing [non-compete clauses] are being put into contracts without thought,” says Hena Singh, a partner with an employment law practice in Toronto who works frequently with both employers and employees in tech.
“We’re seeing non-competes getting popped into every contract and they’re long. You’re seeing six, eight, nine, 12-month non-competes,” Ms. Singh says. But often a company “doesn’t need six, eight or 12 months to recover from someone’s departure. Sometimes they need two weeks and sometimes they need no time.”
In the technology industry, the agreements are also filtering down the hierarchy. “More and more junior- and entry-level employees are being met with offers of employment that include restrictive covenants including non-compete clauses,” BLG’s Mr. Certosimo says.
In some cases, that is because U.S. companies with Canadian divisions seek to apply “an American legal approach on employees in Canada,” he adds.
Stuart Rudner, a Toronto lawyer with his own employment and HR practice, says the result can be a fear factor. “Even if it’s non-enforceable, most people will assume that it is and they won’t take their chances,” he says. “It might be a weapon the company can use to make your life difficult.”
The cost of possible legal action alone is daunting. “If you’re a fairly junior employee, or even if you’re an executive, forking over the amount of money it costs to defend a complex case – you’re talking potentially getting into the six figures – not everybody can afford that,” says Daniel Chodos, the lawyer who represented Mr. Wright in his case against Ceridian. Even when employees win, courts don’t usually award them full costs.
“The other problem is: More and more companies are asking at the front end whether you have any restrictions in your contract before they hire you,” Mr. Chodos says.
“The system’s broken when it comes to this stuff,” Ms. Singh says. She says Canadian courts have taken the right approach by striking down overly broad clauses. "But employers do have a great deal of power in these circumstances, and the power often achieves a result that’s inconsistent with the law.”
Graeme Moffat, a tech-startup founder who is now a senior fellow at the Munk School of Public Policy says non-compete clauses are being abused in Canada. But employers won’t give them up without a struggle.
“Every tech company in Canada, and a lot of other companies out of the tech sector, tries to get all of their employees to sign non-competes. It’s for intellectual-property protection and it’s a [way] of restraining competition that they try to maximize,” Mr Moffat says. “And that’s a rational course of action, which is why it’s not just going to go away on its own.”
It’s easy to understand why tech companies in particular are determined to use any tool they can to guard their intellectual property. “They have fiduciary obligations to their shareholders to try to protect the company in all ways possible,” says Michael Hyatt, a Toronto-based entrepreneur and co-founder of the successful startup BlueCat Networks Inc., which makes network security software.
Mr. Hyatt says he prefers to try to retain employees by treating them well, but concedes that non-competes are a powerful tool. “I don’t think the clauses should be done away with,” he says. “But I think the behaviour of the employee is more important.”
In Ceridian’s case against Mr. Wright, the company argued in court that the former employee had knowledge of a particular technological solution and “the trade secret is kept in [his] head.”
But the court ruled that Ceridian’s non-compete clause – which was for “up to” 12 months, covered all of North America and said Mr. Wright could not provide services “in any capacity to any business competitive with Ceridian or any of its subsidiaries or affiliates” – was too broad.
Guarding proprietary information is crucial, but non-compete clauses can be like using a sledge hammer to kill a fly. Many lawyers argue that concerns about losing a company’s secrets can be addressed more precisely and effectively using narrower clauses.
Confidentiality or non-disclosure clauses bar employees from sharing sensitive information with competitors or the public. A non-solicitation agreement restricts an employee from pursuing company clients, vendors or employees for a specified period after the employee leaves. They’re often used with departing sales representatives, for example.
In Canada, another legal problem with overly broad non-compete clauses is that they can endanger those narrower clauses as well.
There is case law to suggest that if a judge finds a non-compete clause to be overly broad, he or she could strike down both the non-compete and any non-solicit provisions, says Catherine Coulter, a partner with Dentons in Ottawa. “There have been courts in Canada that have said ‘If you’re going to reach too broadly, we’re not going to allow you to have anything.’
“If you can protect your interests with a solid confidentiality agreement and/or with a solid non-solicit agreement for a period of time, then why risk putting a non-compete covenant out there?” Ms. Colter adds.
Some tech executives, particularly those with startups, say they’re trying to rely more on common sense and employees themselves, rather than non-compete clauses. “I don’t depend on the clause. I depend on treating employees really well and if they decide to do something like that [leave for a competitor], I think they’re risking reputational harm long-term,” BlueCat Networks’s Mr. Hyatt says.
“When a junior employee goes to a competitor, they risk a lot of relationships and a lot of goodwill,” he says. “And why would you do that? Although things are hot today, they may not be hot tomorrow. People should care about relationships more than the clause.”
Fredericton-based entrepreneur Mark McAllister faced litigation himself when Montreal-based CGI Inc., his former employer, sued him over a non-compete clause in 2012. He went on to start his own digital health company, VeroSource, which has expanded from three to 13 employees in the past year and a half. Mr. McAllister decided to use non-disclosure clauses, rather than non-competes, with his staff.
“Our legal advice was to absolutely include a non-compete. It is the way things happen here in Canada,” Mr. McAllister says. “But when it came down to it, we really care more about confidentiality – about protecting our company’s secrets. If someone doesn’t want to work here, they should be able to work elsewhere. So fundamentally people don’t feel that they’re trapped.”
But Mr. Hyatt says that if employers can continue to use non-compete clauses to protect their interests, they will. “You’re not going to see people singing Kumbaya and take all these clauses out because they go on the basis of relationships,” he says.
To get rid of non-competes, Ottawa and the provinces would have to ban them or overtly limit their enforceability. “Using non-compete clauses is the wrong way to protect IP. If we’re serious as a country about protecting IP and trade secrets, then we need laws to address that problem directly,” Mr. Moffat says.
And to do that, the politicians will need a catalyst.
Employment law in Canada is split. In most industries, the provinces set standards. But several large sectors, including telecommunications and banking, are federally regulated. Amid persistent concern over the state of innovation in Canada, both levels of government may be missing out on an inexpensive opportunity to spur growth and attract talent, by banning or restricting non-compete clauses in some way.
“The issue of non-competes to me has always been a question of economic dynamism and worker freedom,” says Mr. Moffat, the Munk School fellow. “It’s basically a freebie to whatever government tries to change the regulations and laws around this.”
For the past two decades, a growing body of U.S. research on non-competes has drawn a connection between the strict enforcement of such clauses and lower salaries and decreased employee mobility. A widely cited 2014 Research Policy paper by Matt Marx, Jasjit Singh and Lee Fleming showed non-competes led to a “brain drain” of knowledge workers out of states where they are strictly enforced to areas where the clauses are not enforceable.
In 2015, Hawaii banned the use of non-compete clauses in the tech sector, and research conducted three years later found that employee mobility in the sector increased by 11 per cent and new-hire salaries went up by 4 per cent.
The U.S. Treasury Department along with the White House published reports on the topic in 2016. The reports stated that 30 million people, or 18 per cent of American workers, had a non-compete clause in their employment contract. Then-president Mr. Obama issued a call to action and some states – including Massachusetts, Idaho and Utah – have since taken steps to curb the use or enforcement of non-competes.
Orly Lobel, a professor of law at the University of San Diego, is the author of the 2013 book Talent Wants to be Free and a prominent researcher on this subject. She argues that employee mobility increases knowledge exchange, produces a denser talent pool, attracts workers from other regions and leads to higher pay.
“Regions that don’t enforce non-compete clauses, like California, are winning in the brain-gain/brain-drain game,” Prof. Lobel said in an interview.
But Pierre-Emmanuel Moyse, professor of law at McGill University, cautions that the connection between contractual non-competes and employee behaviour isn’t easy to prove. He and a research team conducted interviews with entrepreneurs and workers in Montreal in 2015 and 2016, and he says they found “no clear chilling effect or clear consequences.” (Although Prof. Moyse says the team didn’t publish the results, because their methodology was not scientific).
In 2016, the Canada 2020 think tank published a short piece urging Canadian provinces to “follow the lead of California and explicitly ban the use of non-compete agreements, to attract and retain talent.”
The paper – by Western University professor Mike Moffatt and Hannah Rasmussen, a researcher who now works in policy at the federal Department of Innovation – said an outright ban on non-competes would lead to “less uncertainty of the rights of workers, increase worker mobility and help Canada attract and retain talent.”
“Such a ban would likely lead to higher wages in many industries, so naturally firms will raise concerns about the effect even modestly higher wages will have on their competitiveness,” the authors said. But the benefits would outweigh the costs. “We believe it is a price worth paying,” they concluded.
Since then, however, there has been little to no public debate over the use of non-compete clauses in Canada. The Globe contacted numerous innovation and tech-related associations – including the Council of Canadian Innovators, the Information Technology Association of Canada and the Brookfield Institute for Innovation + Entrepreneurship – and none of them had a position or comment on the issue. But it remains a hot topic among employment lawyers, who routinely scrutinize case law for trends in how judges approach the terms.
“This is sort of the Canadian way, right?” says Mr. Moffat of the Munk School. “We just kind of wait around for the U.S. to come up with some interesting ideas, and then we copy some of them five years later.”
Editor’s note: Graeme Moffat's title has been updated from an earlier version of this story. He no longer works with Interaxon.
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