Non-compete when selling a business in Canada: what holds up
Courts give a seller’s covenant more room than an employee’s, and Ontario’s ban on non-competes makes an exception for the sale of a business. The four covenants a buyer asks for, and how the payment for one is taxed.
A non-compete signed on the sale of a business in Canada is read under commercial rules, so it holds unless the seller proves it is unreasonable. It should be limited in term and territory to what the buyer needs to protect. Ontario bans employee non-competes, with an exception for certain sales where the seller becomes the buyer’s employee.
What a non-compete in a business sale covers
A non-compete when selling a business in Canada is a promise in the purchase agreement that you will stay out of a competing business for a set period and within a set area. Buyers ask for one as a matter of course. Much of the price pays for goodwill, which is the customer loyalty and reputation you built, and a seller who opened across the street could take it back.
The letter of intent usually names the covenant in a line. The purchase agreement then fixes how long it lasts and where it applies, and that wording decides whether a court would hold you to it. A covenant is any promise of this kind, and a sale usually carries several.
Ontario’s ban on employee non-competes, and the sale exception
Ontario has prohibited non-compete agreements between employers and employees since October 25, 2021. The rule is Part XV.1 of the Employment Standards Act, which the province’s interpretation manual says was added by the Working for Workers Act, 2021.
The province’s guide to the non-compete rules lists two exceptions. The first covers the sale or lease of a business operated as a sole proprietorship or a partnership, where the seller becomes the buyer’s employee immediately after the sale and the two agree that the seller will stay out of competition with the buyer. The second covers executives, a group the guide defines by office, from chief executive officer and president through to any other chief executive position.
Many owners sell the shares of a corporation and then stay on for a transition, which puts two documents side by side. One is the covenant you give as a vendor in the purchase agreement, tied to the price. The other is your new employment contract, and the ESA rule is aimed at that one. The same guide states that non-solicit and non-disclosure agreements sit outside the prohibition. Which promise belongs in which document is a question for your lawyer, and the guide itself sends readers to one. The ban described here is Ontario’s, and selling a business in Ontario covers the province’s other rules.
Why a seller’s covenant gets more room than an employee’s
The leading case is Payette v. Guay inc., 2013 SCC 45, decided by the Supreme Court of Canada on September 12, 2013. Guay inc. had bought the assets of a group of crane rental companies for $26 million, and one of the vendors, Yannick Payette, went on to work for Guay as an employee. Guay later dismissed him. He joined a competitor, and the courts held him to the covenants he had signed in the sale.
The Court held that a covenant tied to the sale of a business is read under commercial rules, which it called more generous than the rules for employment. In that setting the covenant stands unless the seller proves its scope is unreasonable. The Court explained the difference by bargaining power: an employee is presumed to negotiate from the weaker side, and a vendor and purchaser are presumed to meet as equals. The case came from Quebec, and the judgment states that this greater freedom of contract holds at common law as well.
The test is whether the covenant is limited to what the buyer needs to protect the business it bought. The Court looked at its term and its territory, and then at the activities it reaches. It upheld five years because crane rental is a specialized business, and it held that a clause against soliciting customers generally stands even when it leaves out a territory.
The four covenants, and a reasonable version of each
Buyers usually ask for four separate promises, and a court judges each one on its own wording. Take the table as an illustration for a regional service business. The right term and area for your own sale depend on the market it serves.
| Covenant | What it stops you doing | A reasonable version, as an illustration |
|---|---|---|
| Non-compete | Owning or working in a business that competes with the one you sold | A fixed term, such as the five years upheld in Payette, within the area the business serves and limited to its line of work |
| Non-solicit of customers | Approaching the customers of the business to move their work elsewhere | A fixed term, applied to customers served in the year before closing |
| Non-solicit of employees | Recruiting the staff who came with the sale | A fixed term, applied to people employed at closing, with an exception for general job advertisements |
| Confidentiality | Using or sharing the private information of the business | Lasts while the information stays confidential, with an exception for what later becomes public |
The covenant most at risk is the one drawn wider than the business. A clause covering all of Canada for a company that serves one region, or every kind of work when you sold a single trade, gives a seller exactly the argument the Supreme Court said a seller has to make. A buyer who wants the covenant to hold has a reason to keep it tight.
How the payment for a covenant is taxed
Section 56.4 of the Income Tax Act starts from a strict rule. An amount you receive for a restrictive covenant, a term the Act defines broadly enough to include a non-compete, is included in your income. That means it is taxed in full as ordinary income, where a capital gain is taxed on one half, and it falls outside the lifetime capital gains exemption.
The section then sets out exceptions. One applies where the covenant relates to the sale of shares or an interest in a partnership, the amount is added to the proceeds of that sale, and the seller and buyer make a joint election in prescribed form. Another, also by election, applies where the amount is treated as proceeds for the goodwill of a business sold as assets. Each has conditions, so read the price allocation clause with your accountant before you sign. The tax implications of selling a business sets the covenant beside the rest of the bill.
What to settle before you sign
- 01Ask for the term and the territory in the letter of intent, while other buyers are still interested.
- 02Have the covenant describe the business you sold in words that match what it does today, so the restraint follows the actual work.
- 03Keep the right to hold passive investments, such as listed shares, with a carve out written into the clause.
- 04If you stay on as an employee, ask your lawyer which promises sit in the purchase agreement and which sit in your employment contract.
- 05Check that any part of the price allocated to the covenant is covered by an election under section 56.4.
A breach of the covenant is usually a claim the buyer can make against the money kept back at closing, which holdbacks, escrow and warranties explains. Where two or more owners sell together, each signs a covenant of their own, one of the points in selling a business with a partner. The AI Offer reader reads a letter you have received into plain terms, including whether you are expected to stay on. The Quick AI valuation gives a range for the business the covenant protects.
The terms used in this piece are defined in the glossary of M&A terms.
Questions owners ask
- Is a non-compete enforceable when you sell a business in Ontario?
- It can be. Ontario’s Employment Standards Act prohibits non-competes between employers and employees, with an exception where a business run as a sole proprietorship or partnership is sold and the seller becomes the buyer’s employee. A covenant you give as a vendor in the purchase agreement is read under the commercial test the Supreme Court set out in Payette v. Guay inc.
- How long can a non-compete last after selling a business?
- It can last as long as the buyer reasonably needs to protect what it bought. In Payette v. Guay inc. the Supreme Court of Canada upheld a five year term in the specialized crane rental industry. The Court weighs the term alongside the territory the covenant covers.
- Is money paid for a non-compete taxable?
- Section 56.4 of the Income Tax Act includes an amount received for a restrictive covenant in income. Exceptions apply where the amount relates to the sale of shares or of the goodwill of a business and the seller and buyer make the joint election the section requires. Your accountant should check the price allocation before you sign.
- What is the difference between a non-compete and a non-solicit?
- A non-compete keeps you out of a competing business for a term and within an area. A non-solicit is narrower, since it stops you approaching the customers or employees of the business you sold. The Supreme Court held in Payette that a customer non-solicit generally stands even when it names a term and leaves out a territory.