When are non-competition restrictions invalid in franchising?

The Legal Test for Enforceability of Non-Competition Restrictions

For a non-competition restriction to withstand a court challenge in Canada, it generally must contain clear and unambiguous wording about the following three requirements and these restrictions must be commercially reasonable and the least intrusive as possible in order to protect the franchisor’s commercial interests:

1. the nature of the competing business;
2. the time period of the restriction, and
3. the geographic territory of the restriction.

Each one of these three elements of a non-competition restriction must be clearly worded, specific and commercially reasonable.

• The nature of the competing business

A non-competition provision that simply states that the franchisee is prohibited from engaging in a “competing business” is too generic and increases the odds of it being held legally unenforceable. It is likely ambiguous – what does it mean to be “competing” with the franchisor? The clause must identify the type of business or product that is considered to be competing (like selling pizza, for example).

In addition, this business or product must be clearly tied to the nature of the franchise and the franchisor’s need to protect the franchise system.

As an example, in a recent court decision, a judge enforced a non-competition clause that prohibited the former franchisee from “engaging in a business that is similar to or competitive to [the franchisor] in the sale of pizza and other Italian food items for take-out”.  The judge ruled in favour of the franchisor because the clause clearly defined what was considered to be a competing business.

While this is an example of an enforceable description of a competing business, many non-competition clauses in franchise agreements in Canada are too generic and potentially unenforceable for this reason.

• The time period

The non-competition restriction must clearly define the time after the franchise agreement has terminated or expired during which it will be in force. This time restriction must be clearly defined and commercially reasonable to the minimum amount of time that the franchisor legitimately needs to protect the franchise brand. For example, in some cases a restriction of two years may be considered reasonable, but a restriction of five years may be considered excessive and unreasonable.

• Geographic territory

Territorial restrictions usually establish a defined radius from the franchised location and any other location in the franchise system. The definition of territory must be specific, clear and reasonable. A non-competition restriction must have territorial boundaries that are clear and that are the least intrusive restrictions that the franchisor reasonably requires to protect the franchise system.

If a territorial boundary goes beyond these limits, it increases the odds of the non-competition restriction being unenforceable. The rule of thumb is that the smaller the radius, the greater the chance that the restricted radius will be considered valid if legally challenged.

What is considered an appropriate geographic territory often takes into account the nature of the franchised business and its customer base.  As an extreme example, a territorial restriction stating that the former franchisee must not operate a competing business anywhere in Canada is likely unenforceable.  Similarly, an unduly large restricted territory from the franchised location or any other franchise location is likely enforceable: for example, a coffee shop that restricts a competing operation within the whole city is likely invalid.

A court may take into account the proximity of the customers to the store location in question.  For example, if the bulk of the customers come to the location from within two kilometers or less, and the non-compete territory is for a five-kilometer radius, that territorial restriction may be considered unreasonable and thus unenforceable.

In one case, the non-compete territory was for a thirty-mile radius from the nearest franchise store for a period of eighteen months.  The judge ruled that the franchisor had no legitimate interest to protect within such a large radius and it was contrary to public policy to enforce such a restriction.

Another factor for consideration is whether the territory description is clearly defined and if there is potential ambiguity in the definition of the territory.  In a recent real estate franchise dispute, the franchisor sought to prevent a franchisee from operating a competing business within the “Brantford Peninsula”.  However, there is no geographic region that is called the “Brantford Peninsula”.  (There is a “Niagara Peninsula”, a “City of Brantford” and “Brantford County”, and surrounding areas and cities that are often referred to as “Greater Brantford”).  The court held that this description was ambiguous and ruled that the non-competition restriction was invalid.

Summary

The outcome of a franchise non-competition dispute in Canada will be impacted by the technical requirements relating to the description of the business, and the time and radius of the restriction. All these must be unambiguous and commercially reasonable for the legitimate protection of the franchise system.

In order to ensure the enforceability of a non-competition restriction in a franchise agreement, franchisors and their legal advisors must carefully draft their agreements to meet strict legal standards. Franchisees and lawyers representing them should be aware of their potential rights and responsibilities when heading into a termination of a franchise agreement.

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The information contained in this article is provided for informational purposes only and does not constitute legal advice. Readers should not act on this information without seeking professional legal advice from a lawyer experienced in this area. The content in this article may not reflect the most current legal developments, and the application of law can vary in different provinces and territories. As such, the information in this article is not guaranteed to be complete, correct, or up to date. The author and the publisher of this article disclaim all liability for any actions taken or not taken based on any or all of the contents of this site.

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