March 2, 2016

Ontario Court of Appeal refuses to enforce non-competition covenant because franchisor had no plans to develop the area

Most franchise agreements contain non-competition covenants (also called restrictive covenants), which prevent the franchisee from competing with the franchisor for a period of time after the franchise agreement is terminated. Ontario courts have come out strongly in favour of enforcement of non-competition covenants in franchise injunction proceedings, citing the risks to a franchisor’s goodwill and ability to “maintain the integrity of the chain” if non-competition covenants which are reasonable as to scope and time are not enforced (see e.g. Home Instead, Inc. v. 244674 Ontario Inc., 2015 ONSC 7630; see also Quiznos v. 1450987 Ontario Corp., 2009 CanLII 20708 (ONSC)).

However, in a recent decision dated February 29, 2016 (MEDIchair LP v. DME Medequip Inc., 2016 ONCA 168), the Ontario Court of Appeal refused to enforce a non-competition covenant because the franchisor did not intend to open another franchise store within the protected geographic area. The court ruled that non-competition covenants must be limited to protecting “the legitimate interest of the franchisor” and cannot go further. While the court acknowledged typical justifications for enforcing non-competition covenants in a franchise relationship (involving protection of goodwill, trade secrets and methods of operation), the court decided these justifications were not warranted if the franchisor no longer intended to operate within the protected territory. By deciding it no longer will operate within the protected territory, the court ruled, a franchisor effectively acknowledges that there is no legitimate interest to protect within the defined scope of the covenant.

While the decision is unlikely to have any impact on franchisors who continue or plan to continue operating in the same protected area after a franchise relationship ends, the case could have an impact on a variety of franchise scenarios involving system-downsizing or franchisor uncertainty about a market, for example. A franchisor considering enforcement of a non-competition clause in these scenarios must give serious thought to its “legitimate interests” at stake before seeking to enforce.