February 14, 2012

Restrictive competition covenants – Part 1


This is Part 1 of a 3-Part series. View Part 2 and Part 3.

Non-solicit, non-compete and other types of  restrictive competition covenants are among the most difficult of franchise controls to properly structure.  Canadian courts will strike down a covenant that curtails the franchisee’s freedom to carry on a trade, profession or business unless the restraint meets a three-fold test of reasonableness: first, the franchisor must have a legitimate interest worthy of the court’s protection; second, the ambit of the restraint, its time duration and its geographic area of operation must be no more than is necessary to protect that legitimate interest; and third, the restraint must not be harmful to the public interest.

In the employment setting our courts will readily enforce reasonable restrictive covenants proscribing use of an employer’s trade secrets and confidential information, or soliciting the employer’s trade connections.  Absent very special circumstances, however, the courts have consistently struck down a general restriction on an ex-employee’s freedom to carry on a competing business.  In contrast, in the setting of a sale of a business our courts will readily enforce a general non-competition covenant if the court is satisfied that its only purpose is to allow the buyer of the business reasonable time within which to replace the image that the seller has established in the minds of the business’s customers with the buyer’s own image, free of competition by the one person most familiar with the business, the seller.

Traditionally, our courts have viewed the franchise setting as lying somewhere on a continuum between the employment and the sale of a business settings, and the difficulty for the covenant drafter is to determine in advance just where on this spectrum a particular franchisee’s case will fall.  There is little problem supporting reasonable covenants not to use or disclose the franchisor’s trade secrets and confidential information, for our courts readily enforce these in both the employment and the sale of business settings.  There is also little problem supporting a reasonable non-solicitation covenant, for absent special circumstances, our courts seem prepared to believe that customers come to a franchised outlet because of the licensed trade-marks, rather than because they have been charmed by the franchisee owner of the outlet.  The real difficulty is in supporting non-compete covenants, and these come in two flavours: the “in-term” covenant, which operates only while the franchise relationship continues, and the “post-term” covenant, which operates only after the franchise relationship ends.

We will discuss in-term and post-term non-competes in greater detail in the next instalment of this blog thread.