Restrictive covenants protect against misuse of corporate info
While a unanimous shareholders’ agreement devotes most of its contents to what happens during the life of a business relationship, certain clauses deal with putting restrictions on departing shareholders, says Toronto corporate lawyer Anton Katz.
Katz, principal of Anton M. Katz Barrister & Solicitor, says these types of clauses, known as restrictive covenants, are included in an agreement on the premise that a departing shareholder could become a competitor.
“Presumably, but not necessarily, they’ve had access to confidential material during their tenure with the corporation, and there’s potential for misuse of the information,” he tells AdvocateDaily.com. “The last thing a corporation wants to do is finance a competitor. You want to protect against a departing shareholder being paid for their shares then using that money to set up shop and compete against the corporation.”
There are generally three types of restrictive clauses — non-competition, non-solicitation and confidentiality — and the idea behind them is to constrain the shareholder from breaching those covenants, Katz says.
Non-competition, as the name implies, is a clause that restricts a shareholder from operating a competing business within a specific geographic radius for a defined period of time.
“In order to be enforceable, the scope of the business needs to be defined, and the geographic area and length of time need to be set out to ensure a valid non-compete clause,” Katz says.
A non-solicitation covenant prohibits a departing shareholder from poaching clients and/or employees of the business, he says.
“Once again, the length of time needs to be set out,” Katz says. “One can go further and define the term ‘client.’ For example, is it all customers going back to the day the business was incorporated 100 years ago, or is it clients within the past three years? What about prospective clients who were being pitched?”
He says the same consideration should also be given to defining ‘employee’ in a non-solicitation clause.
“Is it all employees, or is it just ones who have been with the company for a certain period of time?” Katz says.
The third restrictive covenant — confidentiality — is usually drafted as a compendious definition, but sometimes may include specifics such as a client list or other privileged information.
Katz notes that although the main purpose of a shareholders’ agreement is to plan out the legal regime during the time the parties are together, it’s equally important to set out what happens after the relationship is over.
“Shareholders can have access to very valuable confidential information, client lists and intellectual property,” he says. “You want to ensure that they don’t misuse it when they’re gone.”