Are non-competition restrictions enforceable?

What Types of Agreements Use Non-Competition Restrictions?

In business, non-competition agreements are used in a variety of contexts, including the following:

• Buy-Sell Agreements: The purpose of non-competition restrictions in buy-sell agreements is to prevent a seller of a business from engaging in competition with the buyer of their original business. This protects the buyer’s investment in the business that they purchase.
• Shareholder Agreements: The purpose of non-competition restrictions in shareholder agreements is to prevent a shareholder from competing with the company during the time that the person is a shareholder and for a period of time after the person sells their shares in the company. This protects the company from competition by an insider.
• Franchise Agreements: The purpose of non-competition restrictions in franchise agreements is to prevent a franchisee from competing with the franchisor, the franchise system or other franchisees during the term of the franchise agreement and for a period of time after the person leaves the franchise. This is designed to protect the franchisor, the franchise system and other franchisees from competition from a franchisee, or former franchisee, because of the unique know-how and confidential information that they had access to in the franchise system.
• Employment Contracts: The purpose of non-competition restrictions in employment agreements is to prevent an employee from competing with the company, during or after their employment, to protect unique or confidential information that the employee has access to during his employment (this article does not deal with these types of non-competition restrictions).

What is the Legal Test for Enforceability of Commercial and Franchise Non-competition Agreements?

Commercial and franchise agreements have different legal standards for the enforceability of non-competition agreements.

In commercial agreements, the legal threshold for the enforceability of non-competition agreements is relatively low. It is thus easier to enforce these restrictions in general commercial agreements. The legal standard in commercial agreements is discussed in our article, Poor Drafting Can Void Commercial Non-Competition Restrictions.

In franchising, the legal threshold for the enforceability of non-competition agreements is much higher. The courts apply a higher degree of scrutiny to non-competition agreements between franchisors and franchisees. Unlike in commercial agreements, franchise agreements are normally standard form agreements that involve little or no negotiations and there is typically a high degree of power imbalance between franchisors and franchisees. For these and related reasons, for franchise non-competition agreements to be legally enforceable, they need to withstand a higher level of scrutiny by the courts. The test for the enforceability of non-competition agreements in franchising is discussed in our article, When Are Non-Competition Restrictions Invalid in Franchising?

Generally, franchise non-competition agreements will have better odds of withstanding a challenge if they meet the following three legal elements:

1. The restriction must clearly define what is considered a competing business. The agreement needs to carefully set out what business activity is to be restricted. It may not be enough to state that a party must not engage in a “competing business”. That is too generic a description and does not define with a high degree of certainty the type of business that is considered competitive. For example, a food QSR business should describe the key items of food that are to be restricted, such as the sale of burgers or pizza.
2. The time period of the restriction must be commercially reasonable. The length of the restriction should be reasonable in relation to the time that the franchisor needs to protect the franchise system and the location in question. A restriction period of several years may be reasonable for one type of a business but possibly excessive for another.
3. The geographic territory of the restriction must be commercially reasonable. The same rule applies to the geographic area of the restriction. The area of the restriction should not be bigger than the area that the franchisor reasonably needs to protect the franchise system and the location in question. For example, it may be commercially unreasonable for a pizza franchise to restrict a former franchisee from operating a pizza business anywhere in Canada or even a whole city. As before, different types of businesses will merit different geographic protection areas. For example, a dry cleaning depot will probably require a much smaller geographic protection area than a large restaurant or a service business with a customer base that is spread over a larger area.

Commercial Non-Competition Cases

Payette v. Guay (2013)

This is an important decision from the Supreme Court of Canada that involved the sale of a business. The Court held that, to be reasonable, the non-competition restriction had to contain clear and unambiguous terms about the extent of the activity prohibited, period of time for which it was in effect and the geographic territory of the restriction. This decision is analyzed in greater detail in our article, Supreme Court Favours Enforcing Commercial Non-Compete Covenants.

Revel Realty v. Constabile (2022)

In a more recent decision of the Ontario Superior Court, a real estate brokerage, Revel Realty, set up a new office near an existing office that had the effect of competing with the existing office. It did not consult or seek the consent of the agents in the existing office. As a result, eight real estate agents working out of the existing office left to set up their own new brokerage.

Revel Realty brought an injunction application to restrain those agents from competing with it on the basis of a non-competition agreement with the former agents.

The court dismissed the injunction application on the basis that the non-competition agreement was likely not enforceable.

• Invalid territory description: The non-competition agreements had an incorrect territory restriction: it described “Brantford Peninsula” which is not a known geographic area.
• Unreasonable time restriction: The non-competition agreements were for either a five or three-year restriction. The court found these restrictions to be excessive and commercially unreasonable since Revel’s decision to bring on a new team had already restricted the agents’ ability to operate and was the reason they left the brokerage.

In addition, the court held that Revel did not have any genuine commercial interests to protect. In the real estate industry, connections are made with the individual agents, not the brokerage, and there were no trade secrets or confidential information at risk.

The court also had concerns about Revel acting in bad faith in putting its agents at a disadvantage by opening a competing office with a new team without consulting with the original team. For more about this case, please see our article,  Court Dismisses Non-compete Injunction Application by Real Estate Brokerage.

Franchise Non-Competition Cases

Garcha Bros Meat Shop Ltd. v. Singh (2022)

In this case, the principal of a former franchisee transferred the lease of the business to his sister who started operating a similar meat shop out of the same location.

The franchise agreement of the terminated franchisee contained a non-competition restriction within a 10 km radius for a period of 30-months after termination. The court rejected arguments that the restriction was ambiguous and ruled in favour of the franchisor. It held that the transfer of the lease to the principal’s sister was not an arm’s length transaction and that the principals of the former franchisee incorporated the new company with the sole purpose of defeating the non-competition restrictions.

For a more detailed analysis of this decision, see our article, British Columbia Court of Appeal Upholds Injunction Against Company Controlled by Sister of Former Franchisee from Operating a Competing Meat Shop.

MEDIchair LP v. DME Medequip Inc. (2015)

This decision hinged on whether the franchisor had a legitimate interest to protect in the territory where the former franchisee operated.

The franchisor of the MEDIchair franchise system was expanding through the acquisition of a group of Motion Specialists store, while reducing the number of franchised and company-owned stores operating under the MEDIchair brand.

A MEDIchair franchisee decided not to renew its franchise agreement and de-branded its store, but continued to operate its business as usual in the same location with the same merchandise and employees.

The franchise agreement restricted the former franchisee from operating a store “similar to” the franchised store within a 30-mile radius of its former store or the nearest store for 18 months.

The former franchisee claimed that the wording “similar to” was an ambiguous definition of constituted a competitive business and that there was no definition in the franchise agreement of what the MEDIchair business meant. To support its argument, the former franchisee claimed that the MEDIchair system sold many different products that varied from location to location.

The evidence also showed that the franchisor already ran a Motion Specialist store in the contested territory, and, thus, had no plans to setup or operate a MEDIchair store in that territory.

The Court of Appeal for Ontario ultimately reversed the decision of the application judge and held in favour of the franchisee on the basis that the franchisor had no legitimate interest to protect in the contested territory since it did not intend to operate there. For a more detailed discussion of the appellate decision, see our article, Franchisor Cannot Enforce Restrictive Covenant In A Territory Where It Does Not Intend To Operate.

Conclusion

While non-competition restrictions can be important to safeguard commercial interests, they must adhere to legal standards of unequivocal restrictions and commercial reasonableness. The enforceability of non-competition restrictions in commercial arrangements vary from franchise relationships. In franchising, the courts impose a higher level of scrutiny to the technical elements of the restriction and the parties’ motives and conduct.

Depending on the context, parties should carefully examine the contractual terms of the restriction as well as the evidence about the nature of the business, its customers, the parties involved, the territory, etc., when assessing whether a non-competition restriction is likely to be enforceable.

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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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