Can a partner who sells out of a partnership be stopped from competing?

This page covers Ontario; check the rules where you are. A partner who sells their interest to the other partners or to an outside buyer may later want to start or join a competing business. Two different questions arise. One is what the law says about competing while a person is still a partner. The other is what, if anything, restricts that person after they have sold. Section 30 of the Partnerships Act is worded around a current partner, so for the second question start with the documents.

What the Partnerships Act says

Section 30 of Ontario’s Partnerships Act is headed “Duty of partner not to compete with firm.” It says that if a partner, without the consent of the other partners, carries on a business of the same nature as and competing with that of the firm, the partner must account for and pay over to the firm all profits made by the partner in that business. The duty is to hand over profits, and the consent of the other partners removes it. The section is worded around “a partner”. It does not, in the text read for this page, say what applies to someone who has already left.

After the sale: what the documents say

Once the interest is sold, start with what the parties agreed. Look in the partnership agreement for a clause that applies when a partner leaves, and in the sale agreement for a covenant given by the seller. If neither has one, ask a lawyer whether any other limit applies. If a clause exists, its scope and time limit matter. The Court of Appeal for Ontario held in Martin v. ConCreate (2013 ONCA 72), a case tied to limited partnership units, that the duration of the general restrictive covenants was unreasonable, because it had no fixed outside limit. Our page on enforceability in Canada sets out the general test.

How the Income Tax Act treats the payment

Under s.56.4(3)(c) of the Income Tax Act, an amount received for a non-compete can fall outside the general rule that includes such amounts in income. The amount must directly relate to the taxpayer’s disposition of an eligible interest, which includes a partnership interest in a partnership that carries on a business, and the covenant must relate to that business. Conditions include that the buyer deals at arm’s length with the seller, the disposition is to the purchaser or a person related to the purchaser, and both elect in prescribed form. Paragraph (c) is subject to subsection (9), so it does not apply to an amount that would otherwise be income from an office, employment, business or property. This is not tax advice; an accountant should review any such payment.