MEDIchair LP v DME Medeqip Inc., 2016 ONCA 168 is a case with important implications for all franchisors and franchisees. In the decision released on February 29, 2016, the Ontario Court of Appeal struck down a non-competition covenant because the franchisor had no intention of operating a competing business within the geographical area covered by the covenant. Overturning the lower court decision, the Court of Appeal held that a legitimate proprietary interest is necessary to enforce a restrictive covenant.

Coverage of the lower court decision is available on our Consumer and Retail Advisor blog here.

Background

The respondent franchisor, MEDIchair LP, operates a network of franchisees that sell and lease home medical equipment.

In 2008, the appellants purchased a MEDIchair franchise located in Peterborough, Ontario.   As part of the purchase transaction, the appellants agreed to a restrictive covenant that at its core prohibited them from directly or indirectly operating a  “similar business” within a 30-mile radius of their store or the nearest franchise store in Canada, for a period of 18 months upon termination of the applicable franchise agreement.

By early 2015, the ownership of the franchise network had changed hands and the appellants became disenchanted with MEDIchair. Accordingly, upon the expiration of the franchise agreement, the appellants changed the signage on their store and continued to carry on business as usual under a different name.

MEDIchair brought an application to enforce the non-competition covenant. The application judge held that the covenant was enforceable and the appellants were in breach of it by their actions. He noted that it was not relevant whether MEDIchair would be opening a new franchise within the protected geographical area; instead, he gave more weight to the “integrity of the franchise system” as a whole and maintaining the bargain struck by the parties.

The Appeal Decision

The Court of Appeal overturned the lower court decision to enforce the covenant.   It found the covenant to be unreasonable because MEDIchair had no ongoing intention to operate a competing store in the area, negating the proprietary interest that the covenant was intended to protect.

The Court held that:

The application judge erred in law by focusing on the effect of non-enforcement on the MEDIchair franchise system as a whole, without regard to the reasonableness of the restrictive covenant to protect the franchisor’s legitimate or proprietary interest within the temporal and territorial scope of the covenant.

In so holding, the Court emphasized that MEDIchair’s lack of intention was effectively an acknowledgment that it had “no legitimate or proprietary interest”, and therefore the restrictive covenant was “unreasonable as between these two parties in the circumstances”. The Court said:

As the reasonableness of the covenant will be interpreted based on the parties’ anticipated expansion of the business when they entered into their agreement, it should similarly be interpreted to take account of the parties’ expectations at that time with respect to the future continued operation of the franchise in the territory. In this case, the clause was reasonable on the assumption and understanding that MEDIchair would want to continue to operate in the protected Peterborough area, but not if it did not.

Impact

MEDIchair presents a number of takeaways. Notwithstanding the fact that a covenant may be found to be reasonable and unambiguous, Courts will limit the enforceability of restrictive covenants to those reasonably necessary to protect the franchisor’s “legitimate” interests.

In determining the reasonableness of the covenant, the Court will look at the scope of the clause, the parties’ plans for the business, as well as the “parties’ expectations at that time with respect to the future continued operation” of the business within the geographical area.   If upon engaging in this fact-specific analysis there remains no legitimate interest to protect –  then the covenant will be held unenforceable.

Case Information

MEDIchair LP v DME Medequip Inc., 2016 ONCA 168

Docket: C60733

Date of Decision: February 29, 2016