Non-Competes: When Less Is More

After the Ceridian case, employers should learn to draft post-employment non-compete agreements very narrowly

I REGULARLY GET asked by clients to help them protect their tech-related assets. For a software company, or even a traditional company such as a bank or telco, this includes preserving the value of their software code. One legal mechanism typically used is to have key employees sign post-employment non-competition agreements. A recent decision from the Ontario Superior Court in Ceridian Dayforce Corporation v. Daniel Wright, however, illustrates just how careful you must be in drafting these covenants.

Multiple Legal Levers

Before turning to the important Ceridian decision, it is worth noting that there are multiple legal strategies to help a company preserve its core technology-oriented proprietary assets. The first is copyright, which protects the software code your team develops. However, that only protects against a third party copying the actual software code itself; as long as the second-comer only reproduces your product’s general ideas, it will be hard to protect them under copyright. By contrast, the most powerful form of IP protection (and the hardest to obtain) is patent rights, because patents protect a particular feature or function of the software that no one can reproduce unless they secure a license from you first.

Finally, protecting a trade secret such as a unique artificial intelligence algorithm and related process requires a certain degree of caution. The law will protect your proprietary interest in your new development as long as you keep it secret, meaning you may disclose it only to recipients who have signed strict non-disclosure agreements. In this way you can keep your trade secret for a long time, and the judicial system will help you to protect it.

Employees as Trade Secret Destroyers

One of the biggest threats to unauthorized disclosure of trade secrets is, somewhat perversely, the staff who helped you develop your trade secret in the first place. And because, in effect, all companies are “tech companies” nowadays, the practice has developed that employees, when joining an organization, are required to sign a non-disclosure agreement. Equally, companies use elaborate and lucrative compensation plans, including bonuses and equity or quasi-equity options, to keep key creative staff happy in order to minimize the risk they will leave the company and — whether consciously or inadvertently — disclose your trade secrets to a new employer. When these mechanisms are insufficient, employers still try to limit the flight risk of their top technical staff by various contractual means, chief among them having each developer of trade secrets sign a covenant not to compete against the prior employer for a period of time after the employee leaves the employ of the company. Let’s call this covenant the Non-Compete Agreement, or NCA.

A Cautionary Tale

To use an NCA to prevent a software developer employee from leaving your shop and immediately joining your archrival competitor to do the same for them that said employee was doing for you, you must craft your NCA very, very carefully. The recent Ceridian case teaches us how not to do this. In that case Ceridian, which developed SaaS HR software, had an employee who took part in some of the development effort supporting parts of Ceridian’s software. This employee subsequently left Ceridian to join another company. Ceridian then asserted an NCA, the enforceability of which was the subject of this summary judgment motion brought and lost by Ceridian.

If you wish to address such a situation through an NCA, the NCA must be drafted very narrowly. For example, if your company develops artificial intelligence software for the banking industry and an employee does banking-related artificial intelligence software development for you, then the NCA should restrict the scope of activity to the employee i) joining another company that creates AI software for the banking sector, in order to ii) develop AI banking software for them. However, your NCA should allow the employee to work on any other kind of AI software (other than banking-related) for any other kind of company, once they leave your employ.

One reason the court found the NCA in the Ceridian case to be unenforceable was that it purported to limit its former employees from doing anything for a competitor, not simply writing the same sort of software code he had previously worked on. As the Ceridian decision noted, the NCA, if read literally, would have restricted former employees from even being a janitor for a competitor. That role, of course, would not risk revealing trade secrets, so that extensive restriction would no longer operate to protect a vital proprietary interest of the prior employer.

Keep the Restriction As Narrow As Possible

There was another flaw in the NCA in the Ceridian case. It purported to restrict former employees from working not just for a competitor, but also any affiliate of a competitor, even where the affiliates had nothing to do with software development, let alone developing the type of software that Ceridian was developing. As the judge put it in the Ceridian decision, the affiliate could have been in the business of gift cards, which had nothing to do with SaaS HR software. So, again, by attempting to cast the protective net too broadly — to include affiliates of competitors in unrelated industries — Ceridian was guilty of overreach.

Learning from the Ceridian case, the reasonable restriction in your NCA should cover only those entities of a competitor that make a product or service that competes with the particular product or service that you produce and that the employee directly worked on. In effect, you should be content if the employee goes to work for an affiliate of the new employer as a janitor (i.e., in a different kind of job entirely), and when that affiliate is in an entirely different field from yours.

You might be thinking at this point, “Why didn’t the judge in Ceridian simply cut back the scope of the restriction in the broadly drafted NCA”? The short answer, given by the court in that decision, is that judges will not re-draft NCAs for plaintiffs. While some courts might have done that at one time, those days are long gone. It’s up to you to craft your NCA carefully and precisely; don’t count on a judge revising it for you.

And here’s the thing: if the NCA is too broad it will be completely knocked out in court. So the question is: is it better to get more certainty on a lesser degree of protection or go broader in the NCA and end up with nothing?

Not Too Long in Duration, Either

Assuming you have crafted a narrow scope in the NCA, as suggested above, there are a couple of more tweaks you need to make to the clause. First, the duration of the restriction has to be reasonable, which effectively means it should be for a relatively short period of time. For example, if in your market it is typical that a new release of software comes out once each year, then it`s probably safe to say that any restriction longer than 12 months will be considered overly long, and hence will be found unenforceable. In other words, the duration of the protection again cannot be longer than that which is sensibly necessary to protect the reasonable proprietary interests of the prior employer.

The duration of the NCA should also be made clear when the employee signs the NCA. In Ceridian, the NCA contained an unusual mechanism providing that the duration could be up to one year, and that Ceridian would tell former employees what the actual duration would be at the time employment was terminated. Again, to the court this amounted to unilateral overreach by Ceridian, and made the clause void for uncertainty.

The bottom line is this: to stand any chance of being enforced in a court of law in Canada, the restrictive covenant must be made clear at the outset of the employment relationship and the employee must understand exactly the parameters of the provision. Your NCA should be of a fairly short duration that reflects the business cycle in your industry.

And Geographically Reasonable, Too

In the Ceridian case, the geographic scope of the NCA restriction was “North America.” Ceridian’s customer base was essentially in Canada and the United States. Again, the court found overreach in the clause, because it held that North America included Mexico and the Caribbean, two regions where former employees’ scope of work was not relevant.

The message is clear. The NCA requires a geographic limitation, and it should be as narrow as the actual geographic parameters of the employee’s day-to-day work. If the employee works in a division that serves clients in Canada only, then don`t include the US in your NCA. Or, if the employee covers both Canada and the US, then don’t include Europe. You get the idea.

There are some jurisdictions where post-employment non-competes are truly a non-starter, such as California, where they are banned by law. Canadian jurisdictions are not there yet. A carefully crafted, reasonable NCA still stands a chance of being upheld under the right circumstances, but only if the clause is not guilty of overkill.

George Takach is a senior partner at McCarthy Tétrault LLP and the author of Computer Law.