On February 29, 2016, the Ontario Court of Appeal issued reasons for judgment in MEDlchair LP v. DME Medequip Inc., 2016 ONCA 168, allowing the appeal of the trial level decision (reported at 2015 ONSC 3718) on one important issue: whether the restrictive covenant was unreasonable and not enforceable because the evidence of the franchisor was that it had no intention of opening another store within the protected geographic area. The Franchisor argued that it needed to enforce the restrictive covenant to maintain the integrity of the entire franchise system and ensure that its franchisees knew that they could not walk away from their agreements. The Ontario Court of Appeal disagreed and found the covenant was not enforceable. This decision recognized the Court’s aim to limit the enforceability of restrictive covenants to protect only those with legitimate interests requiring protection for a limited time and within a defined territory.
In this case, the appellants had purchased the Peterborough franchise of MEDIchair LP and had entered into a franchise agreement which included a restrictive covenant preventing them from operating a similar store within a 30-mile radius of their store or the nearest franchise store for 18 months after the termination of the agreement. After a two-year term, followed by a five-year renewal, the appellants decided not to renew the franchise agreement.
When their franchise agreement expired in January 2015, the appellants removed the MEDIchair signage and continued to operate their business at the same premises with the same merchandise and the same employees. They advised their suppliers by email that they were carrying on business as usual under a new name. The trial judge found the covenant was enforceable and the appellants were in breach of it by their actions. He acknowledged that the franchisor may have been experiencing difficulties and that there were no plans to open a Peterborough store, but held that those factors did not make the scope of the restrictive covenant unreasonable, giving more weight to “the integrity of the franchise system, which would be significantly compromised if franchisees were simply allowed to walk away from the terms of the Agreement if MEDIchair was unable to establish that another store was going to open in the same area”.
The Court of Appeal did not agree. It was an error to focus on the effect of non-enforcement on the franchise system as a whole without regard to whether the covenant was reasonable to protect the franchisor’s legitimate or proprietary interest within the specific temporal and territorial scope of the covenant between the parties. The evidence made it clear that MEDIchair had no intention of operating in Peterborough (where it would be in competition with its corporately held Motion store). MEDIchair had effectively acknowledged that it had no legitimate interest to protect within the defined scope of the covenant.
This case confirms that restrictive covenants will only be enforced where there are legitimate interests to protect. In considering whether the duration and territorial scope of a restrictive covenant are reasonable, you need to look at the business and what is reasonable in that context; this will include what the plans are for that area by the person seeking to enforce the covenant. If there is no business case for protection in the area covered by the restrictive covenant, then it won’t be enforced.