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Is a Restrictive Covenant Enforceable where no Legitimate Interests Exists?

The Ontario Court of Appeal’s Decision in MEDIchair LP v. DME Medequip Inc., 2016 ONCA 168

Background

The applicant, DME Medequip Inc. (hereinafter “DME”) operated in Peterborough, Ontario one of the respondent’s, MEDIchair LP (hereinafter “MEDIchair”) franchise stores which sold and leased home medical equipment. DME and MEDIchair signed their latest franchise agreement in 2005, which contained a restrictive covenant. The parameters of the restrictive covenant included a bar on DME from operating a similar business within thirty (30) miles of their store or another of the respondent`s franchise stores for eighteen (18) months of the expiry of the agreement.

In 2011 MEDIchair was sold to Centric Health Corporation (hereinafter “Centric”), which also acquired another competitive company of MEDIchair. After these acquisitions Centric began making business decision which favoured the competitive company, as such business at many MEDIchair stores began to decline.   In 2014 Centric sold MEDIchair and the competitive company to Birch Hill Equity Partners.

In 2015, DEM opted not to renew their franchise agreement with Centric, due to the decline in business.  However, DEM essentially continued to carry on the same business in the same location, but removed all MEDIchair signage and changed their business name to operate as Living Well Home Medical Equipment.
Relying on their 2005 agreement, MEDIchair brought an application to stop DME from carrying on business as per the restrictive covenant. DME argued that the restrictive covenant was not enforceable and therefore they were not in violation of the 2005 agreement. The application Judge found the restrictive covenant to be enforceable, and thus DME was in breach of the 2005 agreement. DME appealed the decision.

Issues

The central issue for the Court to consider was “whether the franchisor was entitled to enforce the restrictive covenant when its evidence was that it had no intention of opening another MEDIchair store within the protected geographical area.” (para 2)

The Ontario Court of Appeal’s Decision

The Court began its analysis by discussing the basic principles of the enforceability of restrictive covenants that have been established by the Supreme Court.  Citing J.G. Collins Insurance Agencies v. Elsley, [1978] 2 S.C.R. 916 (S.C.C.), the Court noted that “[a] covenant in restraint of trade is enforceable only if it is reasonable between the parties and with reference to the public interest” (para 34).  There is a dichotomy between the “important public interest in discouraging restraints on trade, and maintaining free and open competition unencumbered by the fetters of restrictive covenants. On the other hand, the courts have been disinclined to restrict the right to contract.” (para 34).
 
There is a different approach for employment and business contracts, but the tests are essentially the same. The difference rather is that the burden to establish reasonableness is higher for employment contracts than for a business contract. The distinctive burdens are as a result of the different bargaining positions. In an employment contract, there is usually an imbalance of bargaining power which favours the employer. A commercial contract on the other hand does not require the same protections, as such, a restrictive covenant will be enforceable unless it is established on a balance of probabilities to be unreasonable.
 

In the context of a franchise agreement, the Court declined to decide whether the restrictive covenant provision should be treated as it is in an employment contract context because of the potential imbalance of bargaining power. Instead, the Court focused on determining whether there was a legitimate interest of MEDIchair entitled to the protection of the covenant. MEDIchair acknowledged that there was effectively no legitimate interest to protect within the scope defined by the covenant. As such, the Court found that the application Judge erred in the application of the law by failing to assess the reasonableness of the restrictive covenant. The Court found that the restrictive covenant was reasonable when the franchise agreement was entered into. However because MEDIchair no longer had a proprietary interest to protect within the scope of the restrictive covenant it is unreasonable under the new circumstances of the parties.

 Our Thoughts

Restrictive covenants will be determined to be unreasonable and therefore unenforceable if there is no longer a legitimate interest to protect. This principle will apply to an employment contract’s non-compete, non-solicitation or any other restrictive covenants. Employers should be advised that any provision may be unenforceable even if it is reasonable on its terms if the employer no longer has a legitimate interest to protect. Employees should be aware of what can reasonably be enforced upon them at the end of the employment relationship.  

The above article is for general information purposes only and does not constitute legal advice. If you have concerns with regard to the foregoing issues, please make an appointment with one of our lawyers or a qualified legal practitioner elsewhere.
 

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