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Non-Compete Clauses – Common Questions

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We are often approached with questions about non-compete clauses in the context of employment agreements and independent contractor agreements and asked whether or not the clause is enforceable in Canada or the US. While the enforceability of a non-compete clause is determined on a case-by-case basis, we thought it beneficial to provide an overview of common questions we receive:

  1. Are non-compete clauses enforceable?  In many jurisdictions, yes, if drafted correctly. However, courts are always on the lookout for reasons to invalidate non-compete clauses. Indeed, in some US states, including California, non-compete clauses are effectively unenforceable.  California courts will even invalidate employment agreements from other states if the employee is now working in California for a competitor.  Elsewhere in the US, you typically need a legitimate business interest to ensure an enforceable non-compete clause.  In Canada, courts will ask a similar question of whether the company has a proprietary interest worthy of protection. 
  2. What interest is worthy of protection? In both the US and Canada, the analysis is similar.  Courts will ask if a company is protecting trade secrets, confidential information, trade connections or goodwill through the non-compete clause.  If a company is simply trying to prevent competition, the non-compete will likely be unenforceable.
  3. What about independent contractor agreements?  It is possible to apply non-compete clauses to independent contractors but there is a much higher likelihood that such a clause is unenforceable. Additionally, the likelihood that a contractor will agree to a non-compete is significantly lower as contractors are working multiple jobs at the same time and signing a non-compete clause may cause them to lose out on work.  Finally, some courts may interpret the non-compete clause as indicating an employer-employee relationship, which may lead to material labor law issues.
  4. What is a reasonable non-compete?  A company cannot have a non-compete that stops an employee from working entirely except in extreme circumstances, which usually involves a large severance package (for example, applied to a CEO).  Typically, a company needs to limit any non-compete clause by length of time, geographic location and type of work prohibited and to tailor these limits very specifically to the work that a company actually does. 
  5. What about a non-solicit or non-disclosure clause  In Canada, and some other jurisdictions, courts will invalidate a non-compete clause if there are other less restrictive means to enforce company goals.  Often a non-solicitation clause or a confidentiality/non-disclosure clause will operate to accomplish the same objective.

By keeping the above in mind, you should be able to avoid the pitfalls of unenforceable non-competes or avoid them entirely through other clauses.

US and Canada – similar countries, similar privacy laws… right? Wrong.

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We are often engaged to review Privacy Policies from a U.S. and Canadian legal perspective.  In many cases these Privacy Policies were drafted by Canadian counsel without considering the laws of the client’s major market, the U.S.  The privacy laws of Canada and the U.S. are quite different and a failure to comply with U.S. privacy law can have enormous financial implications.  Accordingly, it is critical that Canadian companies ensure that their Privacy Policies are compliant on both sides of the border.

Below we detail three common privacy law issues that Canadian companies have when entering the US market.

1. The US is far bigger and more complex than Canada

In Canada, with a couple of exceptions, the Personal Information Protection and Electronic Documents Act (PIPEDA) covers most privacy law issues in the commercial sphere.  Conversely, in the U.S., companies must comply with several different federal privacy laws, as well as state laws, the latter playing a major role in privacy protection.  This means that companies need to worry about complying with the privacy laws of all 50 states as well as several federal laws.

2. Same words, different meanings

Although both countries write their laws in English (In Canada – en Français aussi), words can have varying meanings under the law.  In privacy law in particular, certain key concepts are very different between Canadian and U.S. privacy laws, and companies that ignore these differences open themselves up to huge liability.

For example, the term personal information, at the core of privacy law in both countries, has different meanings in both countries and in the US there is no standard definition from one law to the next, or one state to the next. This means that while you might be compliant in Canada with the current way that you collect data from customers, the exact same data collection practice may be non-compliant in the US.

Other major privacy law concepts that differ in the US include: privacy of children under 13 years old, standards for “consent” and “breach”, rules for third-party access to personal information and jurisdiction issues.

3. Fines are far greater in the US

The price to pay for not complying with US privacy laws is far greater than not complying with Canadian privacy laws. For example, the Office of the Privacy Commissioner of Canada (OPC), the Canadian privacy law enforcement body, does not have the authority to fine companies for most privacy law violations.

In the US, by contrast, recent fines imposed by the Federal Trade Commission (FTC) and sister body, the Federal Communications Commission (FCC), consistently are in the million-dollar range and even up to $25 million in some cases.  Even simple violations such as gathering temporary personal information of children prior to getting parental consent can garner fines of up to a million dollars.  And be aware, the first piece of evidence that the FTC will use to see if a company is complying with US privacy law, is its online privacy policy. If you haven’t changed your privacy policy from a Canadian law compliant privacy policy to a cross-border compliant privacy policy, you are putting your company at huge risk.

Canada’s population is 1/10 that of the U.S.  For business, this means that most Canadian companies are going to look to the U.S. for revenue generation and in the process create exposure to U.S. laws, including privacy laws.  It’s critical that companies stay on top of their exposure to U.S. laws and engage legal counsel to ensure that their operations are fully compliant.

Our Most Popular Posts of 2018

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With 2018 coming to a close we’ve decided to look back at our most popular blog posts of 2018.   Interestingly, all of these posts are on the subject of capital raising/financing, which should be of no surprise to anyone who works in the technology sector!  Now, onto our most popular posts from 2018:

1.  Priced Rounds

In our most popular post we discussed the benefits to priced financing rounds, rather than convertible instruments, for early-stage financing rounds.  We also cautioned that some investors prefer convertible instruments and others will reject a priced round valuation but accept the same valuation (or higher) as the cap on a convertible instrument.   At the end of 2019, I still prefer priced rounds for early-stage investments but only if a Common share is on offer.   I am not fond of preferred share priced rounds prior to a company’s Series A financing (I’ve seen this more than normal in 2018) as this is too early a point in a company’s life for such a complex financing structure and the additional restrictions that often follow.

2.  Things Every Startup Should Know Before its First Financing

In the runner-up post, we laid out four things every startup should know before embarking on its first financing: (1) know your investment structure; (2) have your investment documents ready; (3) don’t treat investor interest as commitment; and (4) be realistic in the timeline for closing the investment round.  I’ll add a fifth: know all your outstanding equity obligations and clean them up before starting the round.  Put another way – all those equity offers you wrote yourself can’t be ignored and need to be cleaned up before the first financing begins.

3.  Video Game Profit Sharing Structures

Finally, in third place, was our post detailing three common structures for video game studio profit sharing: (1) draft a profit sharing agreement; (2) create a separate company for each game; or (3) issue shares to profit share participants.  While clients came to us with numerous structures for profit sharing in 2018, all went the profit sharing agreement route due to its flexibility.

That’s it for 2018.  Stop by again in 2019 for more posts on the law of startups and video game studios, from a Canadian and US perspective.

Things Every Startup Should Know Before its First Financing

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Startups often email me to assist with a financing expected to close a few days later.  Eager to get the deal going, I ask about deal structure, such as type of investment, investor rights and size of round, only to learn that structure has yet to be determined and no firm commitments have been made by investors.  While there is nothing wrong with these details being TBD, it benefits startups, their investors and legal counsel to fix as many deal terms before expectations of closing take root as until the above is set in stone, there is not deal.

Before beginning your first fundraising round, consider the following:

  1.  Know your structure.  Fixing the structure for your investment round is critical and shows investors that the company is sophisticated.  Options include a priced round, convertible notes and SAFEs.  There’s nothing worse than pitching to an interested investor and being unable to answer questions about the round’s structure.
  2. Have your Documents Ready.  Be ready to close your lead investor quickly if they are ready to move forward with the investment.  While investment documents may be negotiated further, having the documents ready shows professionalism and speeds the transaction toward close.
  3. Don’t treat Interest as Commitment.  Until investors move beyond expressing interest and into reviewing and negotiating deal documents there is little merit to their interest.  In my experience, converting investor interest into investor commitment is much more challenging than expected and you don’t want to plan the company’s direction over the next year based off expressed interest only to find out that you can close 1/2 the amount expected.
  4. Be Realistic in Closing Timeline.  Attempting to close a round in a few days only happens if the above points have been addressed by the company.  Legal counsel can prepare documents as quickly as the client requires but investors won’t move quickly until they know the investment structure and previously received draft documentation.  With this in mind, set a realistic closing timeline.

Closing your first financing is daunting.  By keeping in mind structure, documentation, investor commitments and setting realistic closing time-frames you will put your startup in a better position to successfully close the round.