The problem with non-compete clauses

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Hunter Harrison, the retired chief executive officer of Canadian National Railway Co., has been paying close attention to the fine print of his CN contract lately. So has his former employer.

It all has to do with his desire to go back to work – for CN's rival, Canadian Pacific Railway Ltd. U.S. activist shareholder Bill Ackman has been badgering the resistant CP board with demands that it crown Mr. Harrison its new CEO.

In an November e-mail exchange with CP chairman John Cleghorn, Mr. Ackman said Mr. Harrison couldn't meet CP officials just yet because of a "non-compete clause" in his contract with CN.

As the dispute between Mr. Ackman and CP's board became public in recent weeks, that fine print has been front and centre, along with the question of whether it forbids Mr. Harrison, who now trains racehorses in Florida, from saddling up at CP. Last week, CN took the unusual step of publicly warning him to abandon any thought of taking over CP, and cautioned Mr. Ackman to stop inducing him to do so.

Mr. Ackman said his lawyers have dismissed CN's warning as "absolutely frivolous," and denied any wrongdoing.

However, it is increasingly common for companies to try to restrict the activities of former employees, particularly high-powered ones, once they leave. Employment lawyers say litigation over non-compete clauses is also growing rapidly, as the contents of an employee's head become more and more valuable in a knowledge-based economy.

Whatever the reason, in the eyes of courts in Canada and the United States, the fine print in such contracts is nowhere near as ironclad as some employers might like to think.

In Mr. Harrison's case, Montreal-based CN issued a statement earlier this month saying that a clause in his contract explicitly forbidding him from working for a competitor expired at the end of 2011, two years after his retirement in 2009. A separate provision attached to his pension and retirement arrangements says he also cannot compete with CN, the company said.

But last week, as talk heated up of a coup that would install Mr. Harrison in the CEO's office, CN said it was asking its former boss to reconsider coming out of retirement to lead its rival, noting that Mr. Harrison was "bound by a broad range of confidentiality and multiyear non-competition and non-solicitation provisions."

CN said its board was "closely reviewing all developments concerning these matters with a view to enforce Mr. Harrison's contractual obligations to CN and take all actions necessary to protect the legitimate interests of the company."

Legal experts saying that enforcing such contracts is often an uphill battle. In Mr. Harrison's case, his CN contract falls under the law of Illinois, where he was based. Mr. Ackman has said that blue-chip law firms Kirkland & Ellis in Chicago, Sullivan & Cromwell in New York and Davies Ward Phillips & Vineberg LLP in Toronto have all reviewed the issue and dismissed CN's claims.

Samuel Estreicher, an employment law professor with New York University, said any CN case against Mr. Harrison would appear to be a long shot, although the former CN boss might lose his pension benefits under his contract.

Then there is the confidentiality issue. Mr. Harrison's explicit no-compete clause may have expired, but regardless of what is written in black and white, under the common law, departing employees – in particular senior executives – still owe a duty to their former employers not to disclose confidential information from their old job.

In some U.S. cases, Prof. Estreicher said, courts have forbidden executives from jumping ship to a competitor, but only for a short period of time, ruling that some violation of confidentiality is inevitable. But in those cases, he said, the executives had also been found to have been acting "in a suspicious manner." For example, one person attended strategic meetings even after accepting a new job at a competitor.

Based on the publicly known facts, Prof. Estreicher does not see any grounds for such an injunction in Mr. Harrison's case, given that he has not been accused of acting improperly. Even Mr. Harrison's duty not to disclose key CN information is probably fading now, he said, since he has been out of action since 2009.

"I assume that by now, two years later, he doesn't have much in the way of usable commercial information," Prof. Estreicher said. "… It doesn't sound like it would be a good case under U.S. law."

These kinds of non-compete agreements are not limited to high-powered CEOs. Lawyers in Canada say these agreements are increasingly common for salespeople, engineers, software developers and others – as is litigation over them when companies try to enforce them.

Essentially, while there are some exceptions, strict non-compete clauses are "by default not enforceable in Canada" says Stuart Rudner, an employment lawyer with Miller Thomson LLP in Markham, Ont. But employers, he adds, are still increasingly including them in contracts, despite the fact that courts insist on rewriting them.

"The courts are really loath to enforce them because you are basically telling someone that they cannot work in the industry where they've developed their experience and expertise," he said.

Judges often deem the clauses too broad or vague, too lengthy in the time period they demand, or unrelated to the legitimate business interests of the company. Other similar clauses that forbid former employees from, say, stealing clients from their former employer, are more likely to be upheld, provided they are deemed to be reasonable and unambiguous.

The rise in this kind of litigation may also reflect that the age of lifelong loyalty to one employer has come to an end, Prof. Estreicher said.

"We are moving to a world where nobody is loyal to anyone any more," he said. "The employer's not loyal to the employee, and the employee's not loyal to the employer."

TEAM MOVES

Fights about "non-compete" clauses in Canada are keeping employment lawyers busy – and they don't always involve just one employee at a time.

Stephen Gleave, a lawyer with Hicks Morley Hamilton Stewart Storie LLP, a Toronto management-side labour law firm, said fights over non-compete and related contract restrictions now take up 90 per cent of his litigation practice.

And increasingly, these cases involve conspiracy allegations against senior executives who bolt from a company and take a group of like-minded employees with them, he said.

"Team moves, we call them. What you've done is, you've basically stolen a part of the business without paying for it, and you have moved it somewhere else," Mr. Gleave said. "And that's not appropriate."

Many of the court fights are not easy, as courts tend to frown on non-compete clauses. In 2009, a Supreme Court of Canada ruling said non-competition clauses or other similar "restrictive covenants" would be unenforceable in Canada if any of their terms were ambiguous.

In that case, a contract (drafted by a Toronto lawyer, the court noted) forbade an employee of an insurance brokerage from taking a job for three years with any competitor in the "Metropolitan City of Vancouver." As that is not actually the name of the municipality, the Supreme Court overturned a B.C. Court of Appeal decision and refused to enforce the contract.

Jeff Gray