Supreme Court of Canada
March 7, 1978
Judges: Laskin, C.J.C., Martland, Ritchie, Pigeon, Dickson, Beetz and Pratte, JJ.
The judgement of the Court was delivered by
DICKSON J.: The question for decision in this case is whether a restrictive covenant contained in a certain contract of employment, to which I will shortly refer, is valid.
The facts are, to all intents, undisputed. On April 24, 1956, an agreement was entered into for the purchase by the Collins company of the general insurance business of a competitor, D. C. Elsley Limited. The price was $46,137. The life insurance business and the real estate business conducted by the Elsley company were not included. The agreement contained a covenant on the part of the vendor that it would not, for a period of ten years, carry on or be engaged in the business of a general insurance agency within the City of Niagara Falls, the Township of Stamford and the Village of..Chippawa, all in the County of Wetland, and that the vendor would pay the purchaser $1,000 for each and every breach. The parties entered into a further agreement on May 1, 1956, whereby Elsley was employed as interim manager of the combined general insurance businesses, now owed by Collins, upon terms which included a restrictive covenant almost identical with that contained in the purchase agreement of April 24,1956.
The interim management agreement was short-lived. It was replaced by an agreement of May 30, 1956, by which Elsley undertook to serve as manager of the Collins company's general insurance business in the greater Niagara Falls area, devoting all necessary tine and attention to such employment, subject to the proviso that he might supervise the Elsley company in its real estate and life insurance business. The agreement commenced June 1, 1956, and was stated to continue in force from year to year until terminated by either party upon three months' notice. As things developed, it continued until May, 1973.
Clause 3 of the management agreement contains the covenant which gave rise to the present proceedings. It reads:
3. Subject to the restrictive covenants contained in the Agreement made between the Parties dated May 1, 1956, in consideration of the employment, the Manager shall not, while in the employ of the Company or of its successors and assigns, whether in the capacity in which he is now or in any other capacity, or3during the period of five years next after he shall, whether by reason of dismissal, retirement or otherwise, have ceased to be so employed, directly or indirectly, and whether as principal, agent, director of a company, traveller, servant or otherwise, carry on or be engaged or concerned or take part in the business of a general insurance agent within the corporate limits of the City of Niagara Falls, the Township of Stamford and the Village of Chippawa, all in the County of Wetland; and in-the event of his failing to observe or perform the said agreement, he shall pay to the said Company, its successors or assigns, or other the person or persons entitled for the time being to the benefit of the said agreement, the sum of One Thousand Dollars ($1,000.00) as and for liquidated damages, and the said Mrs. Elsley, wife of the Manager, by her signature hereto, agrees to observe and be bound by the aforesaid covenant.
The clause differs substantially from the restrictive covenant contained in each of the two earlier agreements. It is for a five-year period after cessation of the employment. It is made subject to the covenant contained in the sale agreement of May 1, 1956, for the purpose, no doubt, of assuring a minimum restrictive period of ten years and a maximum restrictive period of the term of employment plus five years. The sum of $1,000 was to become payable for failure on the part of Elsley to observe or perform the agreement; each of the earlier agreements made provision for payment of $1,000 "for each and every breach".
At trial, Collins asked for rectification of the agreement by adding the words "for each and every breach". The evidence disclosed, however, that although both parties had agreed that there should be a restrictive clause the drafting and detail had been left to the solicitor of the parties. The solicitor had died prior to date of trial and neither party had any recollection of the discussion as to the terms of. the clause. There was no memorandum or other written material. In the absence of evidence of mutual mistake leading to the conclusion that the true agreement of the parties was other than as recorded, the application for rectification was properly refused by the trial Judge. Upon such refusal counsel for Collins abandoned any claim for liquidated damages.
To return to the narrative, Elsley managed the combined general insurance businesses for 17 years, from June 1,1956, until May 31,1973, at which time he gave proper notice of termination of employment. During the 17-year period Elsley dealt with the customers of the agency to the almost total exclusion of Collins. To them Elsley was the business, Collins little more than a name. Elsley met the customers, telephoned them frequently, placed their insurance policies and answered their queries. Such were the findings of the trial Judge. People became accustomed to doing business with him on a personal basis and he looked after their insurance needs. He served not only customers of the business he formerly owned, but also Collins' customers.
From 1956 to 1973 the business bore the name "Collins & Elsley Insurance Agencies". During that period, as a convenience, many4 policy-holders paid their premiums at the office of D. C. Elsley Limited, the real estate office of Elsley, because a large part of the business purchased by Collins from Elsley came from the area in which this office was located. As general manager of the combined businesses, Elsley, of course, had access to all policy-holder records; he was familiar with the nature and extent of coverage and the premium paid by each policy-holder. He had knowledge of the insurable assets, financial credit, likes and dislikes and idiosyncrascies of each customer, in a recurring and confidential relationship not unlike that of lawyer/client or doctor/patient. It was only natural that policy-holders would follow him if he made a change.
The matter of the right of a plaintiff to recover legal damages for actual loss sustained where a lesser stipulated amount is mentioned was considered in the House of Lords decision in Cellulose Acetate Silk Co., Ltd. v. Widnes Foundry (1925), Ltd,  A.C. 20. The amount stipulated was £20 for each week of delay in the erection of an acetone recovery plant. The contractors were 30 weeks late. The actual loss suffered was £5,850. The case is of interest in two respects. First, the recovery was limited to £600, the agreed damages. Second, Lord Atkin, delivering judgement, said that he found it unnecessary to consider what would be the position if the stipulated f20 per week were a penalty, adding, p. 26:
It was argued by the appellants that if this were a penalty they would have an option either to sue for the penalty or for damages for breach of the promise as to time of delivery. I desire to leave open the question whether, where a penalty is plainly less in amount than the prospective, damages, there is any legal objection to suing on it, or in a suitable case ignoring it and suing for damages.
There is authority indicating that a penalty clause is ineffective even where it is less than the actual loss suffered (see 12 Hals., 4th ed., para. 118, p. 422, and the authorities cited therein). The result would be that actual damages could be recovered which exceeded the amount stipulated as a penalty. To that extent, the proposition appears to me to be contrary to principle and productive of injustice. The foundation of relief in equity against penalties is expressed in Story, Equity Jurisprudence, 14th ed. at s. 1728, as follows:
Where a penalty or forfeiture is designed merely as a security to enforce the principal obligation, it is as much against conscience to allow any party to pervert it to a different and oppressive purpose as it would be to allow him to substitute another for the principal obligation.
The operation of this relief in the face of contrary agreement by the party is also explained in this section:
If it be said that it is his own folly to have made such a stipulation, it may 15equally well be said that the folly of one man cannot authorize gross oppression on the other side.
It is now evident that the power to strike down a penalty clause is a blatant interference with freedom of contract and is designed for the sole purpose of providing relief against oppression for the party having to pay the stipulated sum. It has no place where there is no oppression. If the actual loss turns out to exceed the penalty, the normal rules of enforcement of contract should apply to allow recovery of only the agreed sum. The party imposing the penalty should not be able to obtain the benefit of whatever intimidating force the penalty clause may have in inducing performance, and thin ignore the clause when it turns out to be to his advantage to do so. A penalty clause should function as a limitation on the damages recoverable, while still being ineffective to increase damages above the actual loss sustained when such loss is less than the stipulated amount. As expressed by Lord Ellenborough in Wilbeam v. Ashton (1807), 1 Camp. 78, 170 E.R. 883: ". . . beyond the penalty you shall not go; within it, you are to give the party any compensation which he can prove himself entitled to". Of course, if an agreed sum is a valid liquidated damages clause, the plaintiff is entitled at law to recover this sum regardless of the actual loss sustained.
In the context of the present discussion of the measure of damages, the result is that an agreed sum payable on breach represents the maximum amount recoverable whether the sum is a penalty or a valid liquidated damages clause.
It should be noted that the above principles concern only the situation where there is a single sum specified for breach of the agreement, or a single breach. Where there are different breaches and the agreement provides for a particular sum of liquidated damages to be payable for each and every breach, there is no bar to awarding the liquidated damages amount for each breach which has occurred to date of trial, and also awarding an injunction to restrain future breaches. In Imperial Tobacco Co. (of Great Britain and Ireland), Ltd. v. Parslay,  2 All E.R. 515, the Court of Appeal held that an agreed sum payable on every breach of a covenant was a recoverable amount of liquidated damages for past breaches, even though an injunction had also been granted to prevent future breaches. In principle, this result is correct. There is no double recovery because the liquidated damages award and the injunction are referable to different breaches.
1. Where a fixed sum is stipulated as and for liquidated damages upon a breach, the covenantee must elect with respect to that breach between these liquidated damages and an injunction.16
2. If he elects to take the liquidated damages stipulated he may recover that sum irrespective of his actual loss.
3. Where the stipulated sum is a penalty he may only recover such damages as he can prove, but the amount recoverable may not exceed the sum stipulated.
4. If he elects to take an injunction and not the liquidated sum stipulated, he may. recover damages in equity for the actual loss sustained up to the date of the injunction or, if tardy, up to the date upon which he should have sought the injunction, but in either case, not exceeding the amount stipulated as payable upon a breach.
5. Where a liquidated damages sum is stipulated as payable for each and every breach, the covenantee may recover this sum in respect of distinct breaches which have occurred and he may also be granted an injunction to restrain future breaches.
Applying these propositions to the present case, in my view the plaintiff was entitled to an injunction and such damages as he could prove to date of trial but not to exceed the sum of $1,000.
I would accordingly dismiss the appeal and direct the payment of such damages, not to exceed $1,000, as the respondent can establish in respect of the period from June 1, 1973, to date of trial, for the lost of commission on all contracts of general insurance sold by Elsley during that period, after taking into account expenses incurred in securing and servicing the contracts..
Success has been divided. The respondent sustained the validity of the covenant; the appellant succeeded in limiting damages to the stipulated amount. I would not award costs to either party.