Can Shareholders Reconcile their Business Withdrawal with their Non-Competition Clause?

The inclusion of a non-competition clause in shareholders’ agreements is common practice: it enables companies and their shareholders to protect their competitive position in the market in the event that shareholders withdraw or sell their shares.

The criteria for assessing the validity of non-competition clauses are clearly established in case law and need not be covered in this article. The application of such clauses in the event of business withdrawal, however, deserves particular attention to preclude the invalidation of non-competition agreements by the courts.

The Non-Competition Clause is not Applicable in Certain Cases

The application of a business-withdrawal clause and the conduct of the party wishing to rescind it may render a non-competition clause unreasonable and unenforceable, even if it appears valid on its face. That is why it is so important to act diligently and in good faith when implementing a business-withdrawal clause, as the Superior Court decision 9395-3271 Québec inc. v. Fleury, 2023 QCCS 2603 reminds us.

In this case, the plaintiff company sought an interlocutory injunction against a former employee, another former employee and shareholder, and companies associated with them. Specifically, the plaintiff invoked the non-competition, non-solicitation, and confidentiality clauses contained in the shareholders’ agreement and/or employment contract as well as the obligation of loyalty.

It is worth noting that the non-competition and non-solicitation clauses contained in the shareholders’ agreement were applicable for a period of three years from the date on which the shares were disposed of by the shareholder leaving the company or withdrawing from company business. While at first glance the non-competition clause may have appeared reasonable, particularly with respect to its duration, it was declared invalid by the court due to the vagueness regarding the start date of the three-year period contained in the non-competition clause, with such vagueness having been caused by the plaintiff’s conduct.

The Importance of Showing Good Faith

Under the company’s shareholders’ agreement, the resignation or dismissal of a shareholder, for whatever reason, entailed:

• The shareholder’s withdrawal from the plaintiff company’s business; and
• The automatic triggering of an irrevocable offer to sell all of the shareholder’s shares to the company’s other shareholders.

When the application for an interlocutory injunction was filed, however, more than six months had passed without the plaintiff having made any progress in the business-withdrawal process following delivery of the notice. According to the court, the plaintiff and the remaining shareholders had not acted swiftly, in good faith, and in accordance with the shareholders’ agreement. Rather than rigorously applying the purchase terms set out in the shareholders’ agreement with respect to the price of the shares, the plaintiff offered to buy back the shares of the departing shareholder at a low price, in sharp contrast to the price specified in the agreement.

Consequently, a dispute over the value of the shares was unavoidable, and the date of disposal of the shares remained unknown or contingent upon the sole will of the plaintiff company and the remaining shareholders. The shareholder who had withdrawn from the company’s business was therefore unduly bound by the obligations contained in the shareholders’ agreement, including the non-competition obligation, for an indefinite period.

The Court’s Conclusion: Overly Restrictive Clauses?

Having ruled that the duration of the non-competition and non-solicitation clauses was excessive, indeterminate, and dependent solely on the will of the plaintiff company, the Court set aside the plaintiff’s application at the interlocutory stage.

Moreover, the Court dismissed the plaintiff’s application for an interlocutory injunction, concluding that the defendants had not breached their obligations in any way whatsoever.

As this ruling has shown, caution must be exercised when drafting and applying non-competition clauses. When a shareholder withdraws from the business, it is important that the party requesting compliance with such action abide in every way by the shareholders’ agreement, in particular with respect to the irrevocable and automatic offer to sell the shares of the departing shareholder. It must also trigger the process of purchasing or redeeming these particular shares promptly and in good faith. Likewise, the mechanism for assessing the value of the shares, which may be included in the shareholders’ agreement, must be complied with, failing which the non-competition clause may be deemed invalid due to its unreasonable implementation scope.

If you have any questions about shareholder disputes, please feel free to contact our Shareholder Disputes team, who will be glad to advise you.

To view the ruling (in French only), click here.

To find out more about interlocutory injunctions, click here.