Legitimate Proprietary Interest Necessary to Enforce a Restrictive Covenant – By Alan Melamud

Even clear, unambiguous, and otherwise reasonable restrictive covenants may not be enforceable. In MEDIchair LP v. DME Medequip Inc., 2016 ONCA 168, the Ontario Court of Appeal overturned a lower court decision enforcing a restrictive covenant, notwithstanding its conclusion that the covenant was not ambiguous or inherently unreasonable. The respondent franchisor, MEDIchair, could not establish a legitimate proprietary interest to protect with the covenant, because it had conceded that it no longer intended to operate a franchise in the same location as the competing business being operated by the appellants, its former franchisees.

The Facts

The appellants (respondents in the application) had purchased a MEDIchair franchise located in Peterborough from a franchisee. The deal had been approved by MEDIchair, and as part of the agreement, the individual appellants had personally agreed to be bound by the restrictive covenant contained in the franchise agreement. Upon termination of the agreement, the covenant barred the appellants from operating a similar business for 18 months within a 30 mile radius of their store or the nearest franchise store:

15.02 RESTRICTION

For a period of eighteen (18) months after the termination of this Agreement, Franchisee, its principals, officers, shareholders, directors, guarantors, personal covenantors, and the spouses and/or children thereof shall not either individually or in partnership, in conjunction with any person or persons, firm, association, syndicate, company or corporation as principal, agent, shareholder or in any manner whatsoever, carry on, or engage in, or be concerned with, or be interested in, or advise, lend money to, guarantee the debts or obligations of, or permit its name or any part thereof to be used or employed by, any person or persons, firm, association, syndicate, company or corporation engaged in any business similar to the business carried on by MEDIchair or any of its authorized Franchisees within an area of 30 miles of the nearest MEDIchair Store business in Canada or the MEDIchair Store business operated by Franchisee prior to termination of this Agreement.

A few years into the franchise agreement, the ownership of the franchise network changed hands and the appellants became disenchanted with its operation. The appellants alleged that the new owners focused their efforts on a different group of stores, Motion Specialties, that had also been acquired by the new owners of MEDIchair and which were similar to the MEDIchair chain. Once the franchise agreement expired, the appellants changed the signage on their store and continued to operate essentially the same business.

In response, MEDIchair commenced an application to enforce the restrictive covenant.

The Analysis

The Court of Appeal found the covenant to be unreasonable solely because MEDIchair no longer had an intention to operate a competing MEDIchair store in the Peterborough area, negating the proprietary interest that the covenant was intended to protect.[1] The Court acknowledged that unlike restrictive covenants in employment agreements, those found in contracts for the sale of a business were presumed to be valid. It rejected the appellants’ argument that the restrictive covenant was ambiguous because what was meant by a “business similar to the business carried on by MEDIchair” was unclear. Furthermore, the Court held that the temporal and geographic scope of the clause was reasonable, assuming that MEDIchair had an ongoing intention to operate in the area.

On cross-examination, however, the corporate parent of MEDIchair had conceded that on account of the presence of a Motion Specialties store, there was no intention to operate a new MEDIchair franchise in Peterborough. In addition, it was admitted that the only purpose for restricting former franchisees from operating a similar business in the same space from which they had operated a MEDIchair franchise, was to allow the franchisor to set up a new store, something that MEDIchair had no intention of doing in the circumstances. The Court concluded that:

The application judge erred in law by focusing on the effect of non-enforcement on the MEDIchair franchise system as a whole, without regard to the reasonableness of the restrictive covenant to protect the franchisor’s legitimate or proprietary interest within the temporal and territorial scope of the covenant.

The Court noted that the Application Judge’s concern about the need to enforce the covenant for the benefit of the viability of the MEDIchair franchise system as a whole did not apply, because the Court was not striking down the clause as generally unreasonable, just unreasonable in the particular circumstances.

[1]              See also, Payette v. Guay, 2013 SCC 45 at para. 61.

 

 

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