Non-Compete Clauses in an Ontario Business Sale Agreement

If you are selling your business, the buyer will often ask you not to open a competing one down the street. If you are buying, you want to make sure the goodwill you are paying for does not walk out the door with the seller. A non-compete clause in the sale agreement is how this is usually handled.

Whether the Employment Standards Act ban applies to that clause in Ontario depends on how the deal is structured and whether you will become the buyer's employee immediately after the sale. Even where the ban does not apply, courts can still decide whether the clause is enforceable. This article covers the main rules and what to check.

The Ontario ban on employee non-competes

Since October 25, 2021, the Employment Standards Act, 2000 bars employers from entering into an employment contract or other agreement with an employee that is, or includes, a non-compete agreement. A non-compete is one that stops an employee, after employment ends, from engaging in any business, work, occupation, profession, project or other activity that competes with the employer's business. The ban covers agreements made before employment starts, during it and after it ends.

Non-competes entered into on or after October 25, 2021 that fall under Part XV.1 of the Act are void. Part XV.1 does not void non-competes entered into before that date; whether they can be enforced is still decided under the common law in the courts.

The sale-of-business exception

The ban does not apply if all three of the following happen:

• A business, or part of a business, is sold or leased.
• Immediately after the sale, the seller becomes an employee of the buyer.
• As part of the sale, buyer and seller agree to restrict the seller from competing with the buyer's business after the sale.

The Ontario guide describes the business as one run as a sole proprietorship or partnership. How the exception applies to a share sale, or to a seller who does not become an employee, depends on the facts and is worth confirming with a lawyer.

There is also an exception for executives. The Act does not stop employers from entering into non-competes with people holding the office of chief executive officer, president, chief administrative officer, chief operating officer, chief financial officer, chief information officer, chief legal officer, chief human resources officer, chief corporate development officer, or any other chief executive position.

Is the clause enforceable?

Even when the ESA ban does not apply, a clause is not automatically enforceable. Courts can still decide disputes about whether a non-compete is enforceable, whenever the agreement was made. The ESA ban does not take that question away from them.

The ESA exceptions therefore do not settle every question about your clause. How this applies depends on the business, the market and the price, so it is worth having a lawyer review it before you sign.

Tax treatment of a non-compete payment

If part of the purchase price is for a non-compete, tax can follow the allocation. The Income Tax Act treats the parts of a payment as paid for the property, services or restrictive covenant they can reasonably be regarded as paying for, and the result follows a reasonable allocation of the price in the agreement.

As a general rule, amounts received or owed for a restrictive covenant are included in the taxpayer's income. That rule is switched off in set cases involving a business or share sale to an arm's length buyer. These include amounts already taxed as employment income, amounts included in proceeds for goodwill where an election is made, and amounts relating directly to the sale of an eligible interest such as shares to the buyer where both parties elect in the prescribed form.

A restrictive covenant election must include a copy of the covenant. For a grantor resident in Canada, it must be filed by the filing-due date for the taxation year that includes the date the covenant was granted. Otherwise it is due six months after the covenant was granted. Speak to an accountant before you set a separate price for the non-compete.

What to do next

• Confirm whether you will work for the buyer after closing.
• Check the date the agreement is signed and the roles involved, including any executive roles.
• Define the time, area and activities in terms that match the business actually sold.
• Decide with your accountant whether any part of the price is for the covenant and which elections apply.
• Have a lawyer review the clause before you sign it.

Frequently asked questions