February 27, 2012

Restrictive competition covenants – Part 3


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

If the court finds that a restrictive competition covenant is unenforceable, the question is whether the court will sever (delete) the offending part from the franchise agreement.  Unlike U.S. courts, a Canadian court will neither re-write an unenforceable covenant nor replace it with a more reasonable covenant; the court will, however, sever the covenant (or its offending parts) provided that:

(a)  the contract expressly permits an unenforceable part of it to be severed, and

(b)  the severed part is a stand-alone covenant in its own right, and not merely one of several different degrees of what is really but a single covenant (e.g. “Don’t compete: (i) in Canada, or (ii) in Ontario, or (iii) in the GTA, or (iv) in Markham, or (v) within two km. of your franchised outlet”), and

(c)  what remains after severance is still meaningful and not contrary to the intentions of the parties as determined by the court from the entire contract.

The following are some practical guidelines for drafting restrictive competition covenants in the Canadian franchise context:

  • The in-term and post-term restrictive competition covenants must be considered together as a whole, having regard both what the franchisor reasonably needs for its protection and the resulting impact on the franchisee.
  • Restraints on customer solicitation should be limited to actual (as opposed to prospective) customers of the franchised business, due to uncertainties inherent in determining who is a “prospective customer”.
  • Often the drafter carelessly uses a “standard radius clause” in the franchise agreement, thereby imposing the same proscribed area on all franchisees in the system.  This “standard radius”, however, is unlikely to reflect the actual area from which a particular franchisee draws his or her trade connection, and it is only this latter area (perhaps expanded to allow for reasonable growth during the time that the restrictive covenant applies) which is worthy of the court’s protection.  Thus the reasonableness of the restraint is called into question at the outset.
  • Each of the restrictive competition covenants should be negotiated (or at the least discussed in detail) with the prospective franchisee before he or she signs up, and the result documented, to help avoid a subsequent claim that the franchisee was unaware of the restrictions or did not understand them or their consequences.
  • Always include in the franchise agreement a clause providing for injunctive relief should a restrictive competition covenant be breached (including an acknowledgment that damages will not be an adequate remedy).  While such a clause is self-serving, it may be of some assistance in establishing irreparable harm, one of the essentials to obtaining injunctive relief.