Should a non-competition clause be used in a family business succession?

A non-competition clause is a promise not to compete after a handover. BDC describes it as a covenant in a purchase agreement in which the vendor promises not to take part in a competing business for a certain number of years after closing. Whether to include one in a family succession is a choice for the family and its lawyer. This page sets out what to weigh, not what to choose.

Who would be bound, and for what

Think about everyone who could compete: the retiring owner, a sibling who is not taking over, a long-serving employee. A clause binds a particular person, so each person who might be asked to sign needs to understand what they are giving up and why. Whether a court would enforce the wording is a separate question, covered in are non-competes enforceable in Canada. A lawyer should draft the clause for the specific business.

Ontario’s rule when the seller stays on

Ontario’s Employment Standards Act, 2000, s.67.2, bars an employer from entering into a non-compete agreement with an employee, and such an agreement is void. Under s.67.2(3), that does not apply to a sale-of-business agreement where, as part of the sale, the seller agrees not to compete with the purchaser’s business and, immediately following the sale, the seller becomes the purchaser’s employee. Section 67.2(4) separately excepts an employee who is an executive, as the Act defines that term. Other provinces run their own regimes, so check the rule where the business operates.

Tax and price allocation

The Income Tax Act defines a restrictive covenant broadly, and under s.56.4(2) amounts received or receivable for one, by the taxpayer or by someone not at arm’s length with the taxpayer, are included in the taxpayer’s income. Section 56.4(3) excepts some amounts received from a purchaser with whom the grantor deals at arm’s length, on conditions that include an election. Subject to s.56.4(5), s.68 treats the part of a payment that can reasonably be regarded as consideration for property, services or a covenant as paid for that item, irrespective of the form or legal effect of the contract. Whether a family member deals at arm’s length is a tax question, so ask an accountant before putting a number on the clause.