Non-Solicitation vs. Non-Compete in a Canadian Business Sale: Understanding the Difference
After a business sale, buyers protect the goodwill they paid for through restrictive covenants: typically a non-compete (preventing the seller from operating a competing business) and a non-solicitation clause (preventing the seller from approaching former clients or employees). Courts treat these two types of restrictions differently. Non-competes are scrutinized more strictly and must be precise in scope, geography, and duration to be enforceable. Non-solicitation clauses, being narrower by nature, are more readily upheld. Poorly drafted non-competes are not rewritten by courts: the Supreme Court made this clear in Shafron v. KRG Insurance Brokers (2009). There is also a significant tax dimension: separate payments made for restrictive covenants are generally treated as income under ITA s. 56.4, not capital gains, which affects how the purchase price should be structured.
What Are Restrictive Covenants in a Business Sale?
When a buyer acquires a business, a significant portion of the purchase price is often attributable to goodwill: the value of customer relationships, reputation, brand, and the seller’s personal knowledge and connections. That goodwill is only as valuable as the buyer’s ability to retain it. A seller who immediately opens a competing business, or who approaches their former customers the week after closing, can effectively strip the goodwill out of the deal.
Restrictive covenants are the contractual mechanism for protecting that goodwill. They are provisions in the purchase agreement (or a separate restrictive covenant agreement signed at closing) that restrict what the selling shareholders may do after the sale closes.
The two primary types:
Non-compete clause: Prohibits the seller from carrying on or being involved in a business that competes with the business sold, typically within a defined geographic area and for a defined period after closing.
Non-solicitation clause: Prohibits the seller from soliciting specific classes of people associated with the sold business, typically former customers (client non-solicit) and former employees (employee non-solicit), again within a defined time period.
Both are restrictive covenants. Both must be reasonable to be enforceable. But the legal analysis courts apply to each is meaningfully different.
The Core Difference: Breadth of Restriction
A non-compete is a broad restraint on trade. It tells the seller: you cannot operate a competing business anywhere in [geographic area] for [duration]. It does not matter whether the seller contacts former clients or not. Simply running a competing business anywhere within the restricted area is a breach.
A non-solicitation clause is a targeted restraint. It tells the seller: you can operate any business you like, but you cannot approach these specific people (former clients or employees) during the restricted period. The seller is free to open a competing business; they just cannot use the sold business’s relationships to build it.
Because a non-compete is broader in scope, it is more commercially valuable to a buyer and more burdensome to a seller. It is also subject to stricter legal scrutiny.
How Canadian Courts Analyze Enforceability
Canadian courts apply a reasonableness test to restrictive covenants in commercial transactions. The central question is whether the restriction goes no further than is reasonably necessary to protect the buyer’s legitimate interest in the goodwill acquired.
The test examines three dimensions:
Duration: How long does the restriction last? Non-competes in Canadian private M&A transactions typically run two to five years. Longer periods are defensible for businesses where the seller’s personal relationships are the core of the goodwill (professional service firms, owner-managed specialty businesses) but require justification. Indefinite non-competes are almost never enforceable.
Geographic scope: Where does the restriction apply? The restricted area should correspond to the geographic footprint of the business sold. A non-compete covering all of Ontario for a bakery that operates in a single municipality is overbroad. A non-compete covering Canada for a national logistics company is reasonable.
Scope of activity: What type of competing activity is prohibited? A non-compete that covers “any business activity” is almost certainly overbroad. The restriction should be limited to the type of business actually sold and should not prevent the seller from working in unrelated fields.
All three dimensions must be reasonable: a non-compete that is reasonable in duration and geographic scope but unreasonably broad in its description of prohibited activities can still be struck down.
Business Sale vs. Employment: A Critical Distinction
Non-competes in employment agreements and non-competes in business sale agreements are treated differently by Canadian courts, for a principled reason.
In an employment context, there is an inherent power imbalance between employer and employee. An employee typically has no meaningful ability to negotiate the terms of a non-compete as a condition of being hired. Courts are therefore skeptical of employment non-competes and have struck them down with some regularity.
In a business sale, both parties are sophisticated commercial actors. The seller received significant consideration, a portion of which is specifically attributable to goodwill that the restrictive covenant protects. The seller had legal counsel, negotiated the terms of the agreement, and freely accepted the restriction in exchange for the purchase price.
This does not mean business sale non-competes are immune from challenge. Courts still apply the reasonableness test. But the context of a freely negotiated arm’s-length commercial transaction means courts approach the analysis differently than they would for an employment non-compete, and sellers face a higher bar when arguing that a restriction they negotiated and signed is unenforceable.
The Shafron Decision: Why Drafting Precision Is Non-Negotiable
The most important Canadian case on restrictive covenants in a commercial context is Shafron v KRG Insurance Brokers (Western) Inc (2009 SCC 6).
The facts: KRG acquired Shafron’s insurance brokerage business. The purchase agreement included a non-compete prohibiting Shafron from working as an insurance salesperson or broker in “the Metropolitan City of Vancouver” for a period of years after closing. Shafron subsequently went to work for a competitor in Richmond, British Columbia, a municipality adjacent to Vancouver but not within the city itself. The question was whether Richmond fell within “Metropolitan City of Vancouver.”
The issue was that “Metropolitan City of Vancouver” is not a defined legal or geographic term. The City of Vancouver is a specific municipality. “Metropolitan Vancouver” might mean the Vancouver Census Metropolitan Area, the Lower Mainland, or some other region. The term was genuinely ambiguous.
At trial and at the Court of Appeal, the courts attempted to resolve the ambiguity by reading in a meaning. The Supreme Court of Canada reversed. Writing for a unanimous court, Justice Binnie held that courts should not use “notional severance” to rewrite an ambiguous restrictive covenant and save it from its own drafting failures. The ambiguity was in the parties’ own agreement. The non-compete was struck down.
The practical lesson from Shafron:
Courts will not fix a poorly drafted non-compete. If the geographic scope is ambiguous, the clause fails. If the definition of “competing business” is unclear, the clause may fail. If the duration uses a trigger event that is not precisely defined, the clause may fail. There is no judicial safety net.
Specific drafting implications for business sale non-competes:
- Define the geographic area by reference to specific, legally defined territories: named municipalities, provinces, or postal code ranges. Do not use terms like “Greater Toronto Area,” “Metropolitan Vancouver,” or “surrounding area” without an explicit definition tied to a recognized legal or statistical boundary.
- Define the prohibited activity precisely by reference to the business being sold. If the business is a residential property management company, the non-compete should specify “residential property management” rather than “any real estate-related activity.”
- Define the trigger for the restriction period: typically the date of closing, not any ambiguous operational concept.
Non-Solicitation Clauses: Why Courts Enforce Them More Readily
Non-solicitation clauses cover two distinct categories.
Client non-solicitation: Prohibits the seller from soliciting, contacting, or accepting business from former clients of the sold business during the restriction period. Note the distinction between “soliciting” (actively approaching a client) and “accepting business” (responding to a client who comes to the seller unsolicited). Many non-solicitation clauses are drafted to cover both. From the seller’s perspective, a clause that prohibits accepting business from any former client, regardless of who initiated contact, is significantly more burdensome and should be negotiated.
Employee non-solicitation: Prohibits the seller from recruiting or hiring employees of the sold business (or the buyer’s organization) during the restriction period. This protects the buyer’s workforce from being disrupted post-closing by the seller re-hiring key people.
Because non-solicitation clauses are narrower than non-competes (they target specific relationships rather than prohibiting an entire category of business activity), courts are more willing to enforce them. The seller is not prevented from working, only from leveraging the specific relationships that were part of the goodwill acquired.
This enforceability difference has a commercial implication: a non-solicitation clause is often better protection for a buyer than a poorly drafted non-compete. A precise non-solicitation clause that will be enforced is more valuable than an overly broad non-compete that a court might strike down.
ITA Section 56.4: The Tax Treatment of Restrictive Covenant Payments
Restrictive covenants in business sales have a significant tax dimension that is not widely understood.
Under ITA s. 56.4(2), an amount received as consideration for entering into a restrictive covenant is generally included in the recipient’s income as ordinary income, not as a capital gain. A seller who receives $200,000 specifically for signing a non-compete agreement includes that $200,000 in income, taxed at the seller’s full marginal rate.
This is a departure from the usual capital gains treatment that applies to most sale proceeds. If the same $200,000 had been part of the purchase price for shares (not separately identified as restrictive covenant consideration), it would be treated as a capital gain (and potentially eligible for the LCGE).
The exception under ITA s. 56.4(3): Where the restrictive covenant is “ancillary” to the disposition of eligible interests (shares of a CCPC or eligible capital property), and certain conditions are met, the amount may qualify for an election that allows it to be treated as proceeds of disposition rather than income. This election can preserve capital gains treatment (and LCGE eligibility) for amounts that would otherwise be income under s. 56.4(2).
The practical implication for purchase price allocation:
Buyers often want a separate allocation of purchase price to the restrictive covenant (because a payment that is income to the seller may generate a tax deduction for the buyer, depending on the nature of the restriction). Sellers generally do not want a separate allocation to the covenant, because it converts what would be capital gain proceeds into income.
This creates a tension in purchase price allocation that is the mirror image of the asset class allocation issue in an asset purchase: buyer and seller have opposing interests, and the allocation should be agreed only after both parties have taken tax advice.
Key rule for sellers: Do not agree to a separate line item in the purchase price allocating specific consideration to the non-compete without first obtaining tax advice on the s. 56.4 consequences.
What Sellers Should Negotiate
From the seller’s perspective, the restrictive covenants in a purchase agreement are post-closing restrictions on your livelihood. Every term should be reviewed carefully, with a view to the following:
Duration: Push for the shortest period defensible given the nature of the business. A two-year restriction is standard for most private M&A transactions. Five years is at the high end and is generally appropriate only where the seller’s personal relationships are the entire business (financial advisory practices, specialized consulting, and professional referral networks).
Geographic scope: Limit the restriction to the actual geographic footprint of the business. If the business operated only in Ontario, a Canada-wide non-compete is overbroad and potentially unenforceable. Even if it is technically enforceable, a narrower scope is less burdensome.
Definition of competing business: Ensure the definition is precisely limited to what the buyer actually acquired. If you sold a retail furniture business, the non-compete should not prevent you from operating in commercial furniture or interior design. If you have other business interests that do not compete with the sold business, confirm those are explicitly carved out.
Non-solicitation scope: solicitation vs. acceptance: If the non-solicitation clause prohibits you from “accepting” business from former clients (not just soliciting), negotiate a carve-out for clients who approach you on their own initiative without any action on your part.
Purchase price allocation. Do not accept a separate allocation of the purchase price to the restrictive covenant without understanding the ITA s. 56.4 income consequences.
How Kalfa Law Firm Helps Sellers
At Kalfa Law we review and negotiate the restrictive covenant provisions in your purchase agreement as part of the overall transaction. We identify clauses that are overbroad, flag ambiguities that could create enforceability disputes post-closing (which cut against both parties), advise on the ITA s. 56.4 purchase price allocation issue in coordination with your accountant, and ensure the covenants you sign are limited to what is genuinely necessary to protect the goodwill the buyer paid for.
The restrictive covenants in a purchase agreement are binding obligations you will live with for years after the sale. Getting the scope right is not a footnote: it determines what you are free to do next.
Draft enforceable post-sale restrictions; speak with the Kalfa Law Firm M&A team
FAQs:
Shira Kalfa, BA, JD, Partner and Founder
Shira Kalfa is the founding partner of Kalfa Law Firm. Shira’s practice is focused in corporate-commercial and private M&A law including corporate reorganizations, corporate restructuring, mergers and acquisitions, commercial financing, secured lending and transactional law.
© Kalfa Law Firm | August 19, 2026
The above provides information of a general nature only. This does not constitute legal or accounting advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.
