Protecting the business’s goodwill after the sale is one of the most important things a buyer can do. Here is how to do it legally and effectively in Ontario.
When a buyer acquires a business, they are not just buying assets or revenue. They are buying trust, client relationships, and the reputation built over years. That is goodwill. And goodwill walks out the door if the selling founder turns around and opens a competing business the next day.
This is why restrictive covenants matter in a business sale. In Ontario, the rules around non-competes changed significantly in 2021. But a critical exception protects buyers in M&A transactions. This article breaks down what that exception is, how it works, and what makes a restrictive covenant enforceable in court.
Ontario’s Non-Compete Ban and the Business Sale Exception
In October 2021, Ontario amended the Employment Standards Act, 2000 (ESA) through the Working for Workers Act. The amendment effectively banned non-compete agreements for most employees. The intent was to give workers more freedom to change jobs without fear of legal consequences.
However, the legislation carved out a specific and deliberate exception: the ban does not apply when the non-compete agreement is entered into by a person as part of the sale of a business or the sale of a person’s interest in a business.
The Statutory Exception
Under the Working for Workers Act, non-compete clauses are permitted in the context of a business sale. If the selling party is also entering employment or some ongoing role with the buyer post-sale, a non-compete can still be valid, provided it meets the legal requirements for enforceability.
This exception exists because the dynamics of a business sale are fundamentally different from a standard employment relationship. The seller is receiving significant consideration. The buyer is acquiring goodwill. Courts recognize that protecting that investment is a legitimate business purpose.
This exception is significant. It means that buyers completing acquisitions in Ontario can legally require exiting founders, owners, and key principals to sign non-compete and non-solicitation agreements as a condition of the deal closing.
What Is Goodwill and Why Does It Need Protection?
Goodwill is the value attributed to a business beyond its tangible assets. It includes customer loyalty, vendor relationships, brand recognition, trade secrets, and the personal reputation of the founders. In many small and mid-sized business acquisitions, goodwill makes up a substantial portion of the purchase price.
When a founder sells their business and then immediately competes against it, they take the very goodwill the buyer paid for. Clients who trusted the founder personally may follow them. Employees who were loyal to the founder may leave. The buyer ends up with a hollow shell of what they purchased.
Restrictive covenants are the legal mechanism that prevents this from happening. They come in two main forms.
Non-compete Clauses
A non-compete clause prohibits the exiting founder or owner from operating or participating in a competing business within a defined geographic area for a defined period of time after the sale closes.
Non-solicitation Clauses
A non-solicitation clause is narrower in scope. Rather than prohibiting competition outright, this clause bars the exiting party from actively soliciting the acquired business’s clients, customers, or employees. General competition remains permitted. It simply prevents them from targeting the specific relationships they are leaving behind.
Why buyers often use both
Non-compete clauses and non-solicitation clauses serve different purposes. Non-competes offer broader protection but face stricter scrutiny in court. Non-solicitation clauses are more targeted and generally easier to enforce. A well-drafted acquisition agreement typically includes both.
What Makes a Restrictive Covenant Enforceable in Ontario?
Courts in Ontario will not enforce a restrictive covenant simply because it exists in a signed agreement. The covenant must meet a reasonableness standard. The leading framework comes from the Supreme Court of Canada decision in Shafron v. KRG Insurance Brokers, 2009 SCC 6, and subsequent decisions that apply the same principles.
For a non-compete or non-solicitation clause to be enforceable, it must be reasonable in three dimensions.
1. Geographic scope
The geographic restriction must reflect the actual territory of the business the seller is transferring. A national non-compete clause for a business that only serves clients in one city is likely overbroad. The restriction should match the real footprint of the business.
2. Duration
The time restriction must be reasonable given the nature of the business and the relationships the clause protects. Courts have generally accepted two to five-year periods in business sale contexts, though this varies by industry and circumstance. Longer periods require stronger justification.
3. Scope of activity
The prohibited activities must be clearly and narrowly defined. Courts are more likely to strike down broad language that prevents the seller from working in any capacity within a vaguely defined industry. The restriction should target the specific competitive threat, not the seller’s general livelihood.
The consideration factor
In the context of a business sale, courts typically treat the purchase price itself as sufficient consideration for the restrictive covenant. Courts are generally more willing to enforce non-competes in business sales than in standard employment agreements precisely because meaningful value has changed hands. The seller has been compensated for agreeing to step aside.
Common Drafting Mistakes That Kill Enforceability
Even with the business sale exception in place, courts strike down poorly drafted restrictive covenants. Here are the most common reasons they fail.
- Using boilerplate language that does not reflect the actual business the seller is transferring or the specific risks the buyer faces
- Setting a geographic scope that is broader than the business’s actual market presence
- Failing to define the restricted activities with enough precision, leaving ambiguity about what conduct the clause prohibits
- Relying on a non-compete alone without a non-solicitation clause as a fallback
- Neglecting to tailor the covenant to specific individuals, especially where multiple founders are selling
- Including the covenant as a generic schedule rather than integrating it into the core purchase agreement with proper representations and warranties
Ontario courts have historically applied a strict approach to overly broad covenants rather than reading them down. In some cases, if a court finds a clause unreasonable, it will void it entirely rather than rewrite it to make it enforceable. This makes precision in drafting critical.
Structuring Restrictive Covenants in an Acquisition Agreement
There is no single template that works for every deal. The right structure depends on the nature of the business, the role of the exiting founders, the purchase price, and the competitive landscape. That said, several best practices apply consistently.
Identify the right parties
The covenant must bind the right individuals. This usually means all selling shareholders who have personal relationships with clients or employees, not just the lead founder. Minority shareholders who had meaningful customer-facing roles should also be included.
Tie the covenant to the closing
Restrictive covenants should be a condition of closing, not an afterthought. The buyer should not be in a position where the deal has closed, but the covenant is still being negotiated. Delay creates leverage for the seller and weakens enforcement later.
Address post-closing employment separately
Many acquisitions involve a transition period during which the selling founder remains on as an employee or consultant. If this is the case, the restrictive covenant in the purchase agreement and any employment agreement must be carefully coordinated. The employment agreement cannot undermine the protections in the purchase agreement.
Include non-solicitation of employees
Client non-solicitation is the most common focus. But employee non-solicitation is equally important. Exiting founders should not be permitted to recruit away the very team that keeps the business running post-acquisition.
What Buyers Should Do Before Closing
Protecting goodwill is not just a legal exercise. It requires strategic thinking during due diligence and negotiation. Before closing, buyers should take the following steps.
- Map the key relationships in the target business: which clients are tied to the founder personally versus the business as an institution
- Identify all individuals who hold significant goodwill, including co-founders, senior partners, and client relationship managers
- Assess the competitive landscape to define a geographic scope that is meaningful but defensible
- Work with legal counsel to draft covenants specific to the business, not pulled from a generic M&A template
- Consider whether an earnout structure or deferred consideration can be used as an additional incentive for the seller to honor the covenant
Berger Law | Mergers & Acquisitions
If you are buying or selling a business in Ontario and have questions about how to structure restrictive covenants, speak with a lawyer who understands the deal, not just the clause.