Are Restrictive Covenants in Restraint of Trade Enforceable: Sometimes
Posted on: June 3rd, 2016 by

The Ontario Court of Appeal’s recent decision in MEDIchair LP reminds me of how difficult it can be for a lawyer to answer the question: Do you think this noncompetition agreement is enforceable?

In Medichair LP, the litigating parties were the franchisee and the franchisor.  The franchisee wanted to resile from of a restrictive covenant in the Franchise Agreement, which provided that when the Franchise Agreement terminated the franchisee would not operate a similar store for 18 months within a 30 mile radius of its store or the nearest franchise store.

The Court identified the promotion of free and open trade and freedom of the right to contract as being the underlying, and competing, policy factors to be balanced in determining whether a restrictive covenant is valid.

The Court referenced the well-known legal test that for a restrictive covenant to be enforceable it had to be “reasonable”.  In particular, the Court accepted that the “test for reasonableness is whether the clause is ‘limited’, as to its term and to the territory and activities to which it applies, to whatever is necessary for the protection of the legitimate interests of the party in whose favour it was granted”.

The words italicized by the Court are key, they set the terms of reference for whether the restrictive covenant being reviewed is reasonable in terms of its duration, geographic scope, and breadth of activities to be curtailed.  A restrictive covenant is not reasonable, and will be struck down, if it is too long in duration, or the geographic area and activities it covers are to broad in scope, based on what is necessary to protect the legitimate interests of the beneficiary of the prohibition.

The reasonableness analysis, therefore, may be considered to be a two-step process.  First, the legitimate interests of the beneficiary, to be protected, need to be identified. Second, these are to be compared to the restrictive covenant to determine if it is “overkill”.

The facts in Medichair LP, provided an interesting factual twist on the usual analysis as to whether the duration and scope of a restrictive covenant is reasonable.  This is because the franchisor had no intention of opening/operating another franchise store in the protected location—as the franchisor’s corporate parent owned another chain of competing franchises and it already had one of these other stores in the protected area.

As such, the Court overturned the judge and held that the restrictive covenant was not enforceable as the franchisor did not have any legitimate or proprietary interest to protect within the geographic area covered by the restrictive covenant.

The Court confirmed that legitimate interests to be protected are those in existence at the time the contract is made, including what might possibly happen in the future.  The Court referenced one of its 1982 decisions in support of this proposition.

In that earlier case, the Court upheld a restrictive covenant that covered all of Canada even though the business to be protected did not operate Canada wide, on the basis that at the time the contract was signed the reasonable expectation of the parties was that the business would be expanded across Canada even though that never happened. The Court in MEDIchair LP reasoned that if the reasonable expectations of the parties at the time of contract covered expansion, then they also covered the reasonable expectation of continued operations by the franchisor in the protected territory—and with that reasonable expectation not materializing the restrictive covenant became unnecessary to protect a commercial interest.

The Court does not explain the basis for arriving at this reasonable expectation at the time of contract—i.e., that the restrictive covenant was premised on the reasonable expectation that the franchisor would continue to operate a franchise in the protected area.  It seems that it may also have been fair to infer, in a commercial setting, a reasonable expectation at the time of contract that the franchisor would want to protect its general brand or goodwill by restricting competition in a certain area whether or not another store would be opened in that area.

Enforceability of restrictive covenants continues to be one of those “grey areas” of the law that lawyers will continue to struggle with.

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