Banning non-competes: lessons from Ontario, Canada?

George Waggott

George Waggott Law, Toronto

george@georgewaggott.com

Roberto Fonseca-Velazquez

George Waggott Law, Toronto

Ontario seeking to compete for technology jobs

Effective 25 October 2021, the Ontario provincial government adopted provisions of the Working for Workers Act 2021, which include new rules on employee non-competition agreements. The changes were brought into force by amending Ontario’s Employment Standards Act 2000 (ESA), with the new rules prohibiting employers from including so-called ‘non-compete’ clauses into their employment contracts or any other agreements with employees. Thus, Ontario became the first – and to date the only – Canadian province to eliminate (most) non-compete agreements.

When the changes were announced, the Ontario government stated that the rules were among various legal changes which were intended to support efforts to attract workers in high growth sectors, including the technology industry. The relevant government press release said that the reforms were to ‘further enable competitiveness by banning unfair non-compete agreements that are used to restrict work opportunities, suppress salary increases and wage growth’. The news release further stated that the reform would make Ontario a more appealing place to work for global talent.

Ontario government considerations

The abolition of non-compete agreements included in the Working for Workers Act was substantially based on a key prior recommendation of the much-publicised government task force. In particular, the Ontario Workforce Recovery Advisory Committee (OWRAC) issued a 2021 report which included a number of concrete recommendations, which included changes which are substantially similar to what is now in effect.^[1] In their report, the OWRAC advised, in Recommendation 13, that Ontario’s provincial government prohibit the inclusion of blanket non-compete agreements and restrict the use of non-compete agreements to protecting certain kinds of intellectual property. In other words, the group advocated for a more nuanced approach to protecting the interests of employers. The report of the OWRAC emphasised that such a policy removes barriers to worker mobility, and thereby encourages innovation and competition, which is ultimately beneficial to all employers.

Non-compete: Ontario rules and rationale

The prohibition on non-compete agreements that was eventually implemented in Ontario applies to any form of ‘non-compete agreement’ with an employee. This type of agreement is defined as follows: ‘an agreement, or any part of an agreement, between an employer and an employee that prohibits the employee from engaging in any business, work, occupation, profession, project or other activity that is in competition with the employer’s business after the employment relationship with the employee and the employer ends’. The non-compete prohibition, which is set out in section 67.2(1) of Ontario’s ESA, is subject to two exceptions where non-compete agreements are allowed. These exceptions are as follows: (1) a non-compete can be part of an agreement where one party sells his company to the other, and then goes to work for the purchaser; and (2) the employee is one of a listed group of senior-level (C-suite) employees. Another key point to note is that relevant Ontario court decisions issued since these changes took effect have confirmed that any non-compete agreements which were agreed to before 25 October 2021 may still be enforceable (subject to being reviewed for reasonableness), regardless of the circumstances or position of the relevant employee.

It is notable that the legislators who drafted the terms of the Ontario non-compete prohibition did not follow the OWRAC’s recommendation that non-compete agreements should be in place as a means to protect intellectual property. Instead, what employers must now contend with is a prohibition which bans clauses which many organisations have had in place for many years.

In its reasoning in support of a prohibition on non-compete agreements, the OWRAC cited a US study by the Economic Policy Institute which argued that non-compete agreements have been harmful to US workers and market competition more generally. When we consider the global context within which many employers now operate, it would seem that Ontario’s opposition to non-compete agreements is part of a broader trend. One very recent example, which is the subject of much commentary (and litigation challenging it) at the time of writing this article is the US Federal Trade Commission’s 23 April 2024 announcement of rules banning certain non-compete agreements.^[2]

Some experienced employment lawyers have noted that, despite the flurry of press releases and policy papers being published by governments, it is not entirely clear how much of a change in the law the Working for Workers Act and Ontario’s non-compete prohibition rules have brought about. One report from the Canadian Bar Association highlighted the fact that Ontario’s 2021 legislation may have merely codified how courts in Canada were approaching non-compete agreements already.^[3] In other words, we may have moved from a position where counsel would advise employers that non-compete agreements are ‘likely unenforceable’ to one where the legislation now provides for certainty, and an ability to say that the clause is ‘not permitted’. When taken together, this means that the practice in Ontario, which is consistent with the approach followed by many employers across Canada, is to avoid even attempting to enforce non-compete agreements.

Why employers often want non-compete agreements

While it seems that currently the trend amongst regulators and policymakers is to take a negative view of non-compete agreements, there are businesses and commentators who argue that there are good reasons to believe that non-compete agreements are an overall benefit. The value is in part based on making sure that employees focus on their ongoing duty of loyalty to the organisation which employs them.

One recent study, co-authored by economists Bhargav Gopal at the Smith School of Business at Queen’s University in Canada and Xiangru Li at Columbia University, involved an extensive review of non-compete agreements and their impact on organisations.^[4] The study found that having a non-compete agreement in place is strongly correlated to the employer being prepared to invest in their employees. Specifically, the study found that in industries where non-compete agreements are popular, employees that sign such agreements are six per cent more likely to receive employer-paid training. Furthermore, those employees who sign a non-compete agreement earn on average 25 per cent more than employees without non-compete agreements. When taken together, this may mean that non-compete agreements may be a tool which helps encourage better performance and financial outcomes for employers and employees.

The Queen’s study also made findings that help explain why employees with non-compete agreements seem to receive preferential treatment. First, non-compete agreements are more likely to be used in knowledge-intensive industries and in higher-wage industries where knowledge is easily transferrable. Secondly, employees who have signed non-compete agreements are five per cent less likely to leave their job and remain at their jobs three months longer than those without non-compete agreements. The picture that emerges from is that when an employee signs a non-compete, employers are incentivised to invest more in developing the skills of that employee and compensating the employee more.

The Canadian findings are also consistent with results from a study published by the US Treasury department.^[5] This US study also found that the evidence suggests the enforcement of non-compete agreements increases the probability that employees will receive firm-sponsored training and higher wages. This study also notes that another benefit of non-compete agreements is that they protect trade secrets. Employees with access to trade secrets are about 25 per cent more likely to be bound by a non-compete than those who do not, which suggests that non-compete agreements are, in practice, used to protect intellectual property rights.

All informed commentators and experienced counsel will be aware that there is substantial evidence that employers can, at times, improperly use non-compete agreements to entrench their market power. Indeed, both studies referred to above suggest that there is strong evidence that many workers are underinformed about non-compete agreements and only about ten per cent of workers report actually having engaged in any form of negotiation with respect to their non-compete. A related article published by the Brookings Institute emphasised that the practice of getting employees to sign a non-compete at the commencement of employment crystallises employer market power and thereby extends it throughout the duration of the employment relationship.^[6] This arguably may result in a decline in innovation and entrepreneurship which the OWRAC’s recommendations sought to address.

Conclusion: challenges for employers

In practical terms, Ontario’s ban on non-compete agreements poses new difficulties for many employers because they will have to adjust their strategies with regards to structuring their employment relationships and retaining key talent. For many organisations which operate across Canada, or indeed across international borders, these rules have already created a domino effect, resulting from the challenge of harmonising employee agreements, especially at the senior level. Since the permitted exceptions are limited, this may lead to a far more pervasive practice across Canada (and potentially elsewhere?) which does away with non-compete agreements altogether. That might actually mean that some employers will be less willing to invest in their employees, who may be more mobile and less tied to their current employer. It seems clear that Ontario’s ban on non-compete agreements is part of an international trend, and it seems equally clear that we will continue to see more jurisdictions instituting restrictions or bans on non-compete agreements in the future.