The recent decision of the Ontario Superior Court of Justice in MEDIchair LP v. DME Medequip Inc. provides valuable guidance to franchisors seeking to enforce a restrictive covenant against a former franchisee. In this case, Justice McEwan considered a franchisor’s ability to enforce a post-termination restrictive covenant against the respondents, who had purchased the franchised business directly from the original franchisee.
The applicant, MEDIchair (the Franchisor), operated a franchise system involved in the selling and leasing of home medical equipment. The respondent, DME Medequip Inc. (DME), was a franchisee in Peterborough, Ontario for approximately twenty years. The franchise agreement with DME contained a restrictive covenant preventing DME from engaging in “any business similar to the business carried on by Medichair or any of its authorized franchisees” for a period of 18 months, within 30 miles of DME’s store or any other franchisee.
In 2008, the two individual respondents incorporated a company, 2169252 Ontario Inc. (216), to purchase the DME franchise. To effect the sale, 216 purchased the shares of DME from its original owner. As part of the Franchisor’s approval of the sale, it required both the individual respondents and 216 to execute personal covenants stating that they would comply with the restrictive covenant given by DME. While the Franchisor provided some documentation to the respondents, it was not otherwise involved in the sale of the franchised business.
After the franchise agreement expired in 2015, DME (now operated by the respondents) removed the Franchisor’s signage and began operating an identical business under the name “Living Well.” The Franchisor applied to enforce the restrictive covenant.
In attempting to avoid the restrictive covenant, the respondents argued that the Franchisor had not complied with section 5 of the Arthur Wishart Act (Franchise Disclosure), 2000 because they did not receive a copy of the franchise agreement. Justice McEwan rejected this argument, finding that the Franchisor was not required to provide disclosure as a result of the exemption in section 5(7)(a)(iv) of the Wishart Act, which provides that disclosure is not required where the “grant of the franchise is not effected by or through the franchisor.” Because DME had been sold directly by its former owners to 216, with little involvement from the Franchisor, the exemption in section 5(7)(a)(iv) applied and no disclosure was required.
In reaching his decision, Justice McEwan held that “the fact that MEDIchair provided some documentation to the respondents has no bearing on whether MEDIchair was bound by the disclosure requirements of s. 5 of the Act.” This finding should reassure franchisors that by providing some documentation to a new franchisee, they will not entirely undermine their ability to rely on an otherwise valid exemption from disclosure in section 5(7)(a)(iv) of the Wishart Act.
The respondents also argued that the restrictive covenant was an unreasonable restraint of trade and was therefore unenforceable. The Court rejected this contention, citing the Supreme Court of Canada’s recent decision in Payette v. Guay for the principle that restrictive covenants in commercial contracts are presumptively lawful “unless it can be established on a balance of probabilities that its scope is unreasonable.” The Payettedecision had clarified that there is distinction between employment contracts, in which the imbalance in power between the employee and employer justifies more rigorous scrutiny of restrictive covenants, and commercial contracts, in which there is greater equality in bargaining power between the parties. The MEDIchair decision is of interest to franchisors because it holds that franchise agreements will be governed by the rules applying to restrictive covenants in commercial contracts, not employment agreements. This is significant because franchisees have previously encouraged courts to apply employment law concepts to restrictive covenants in franchise agreements by arguing that franchise relationships are characterized by an inequality in bargaining power akin to an employer-employee relationship.
In a further attempt to avoid the application of the restrictive covenant, the respondents argued that the restrictive covenant was unenforceable because it was ambiguous. Specifically, the respondents took issue with the restriction on operating a business that was “similar to” the business carried on by the Franchisor or its authorized franchisees.
Relying on the decision in Invescor Restaurants Inc. v. 3574423 Ontario Inc., Justice McEwan held that Courts regularly address the operation of restrictive covenants that enforce a standard of “similar business.” The fact that each MEDIchair franchise did not sell the same products did not create ambiguity in the meaning of “similar business.” While this decision highlights the need for careful drafting of restrictive covenants in franchise agreements to avoid any potential arguments concerning ambiguity, it should give franchisors comfort that courts will give meaning to a restriction on “similar business,” provided the franchise system is itself capable of definition.
Finally, the respondents argued that the restrictive covenant was unreasonable because it was too broad in scope and because the MEDIchair franchise system had been in decline. Both arguments were rejected by the Court.
Specifically, the respondents’ argument that the 30-mile, 18 month restriction was too broad was undermined by the fact that the respondents themselves had obtained an even broader restrictive covenant from the former owners of DME when they purchased the franchise. The Court held that the restriction in the franchise agreement was reasonable in terms of temporal and geographic scope when considering the interest that the Franchisor was seeking to protect.
The Court quickly disposed of the respondents’ argument that the restrictions were unreasonable because the MEDIchair system was experiencing difficulty. The Court declined to focus on the localized issues with the success of the MEDIchair system and evaluated the need to protect the system as a whole. The Court noted that although the Franchisor did not have plans to replace the Peterborough franchise, the integrity of the franchise system as a whole would be compromised if franchisees were allowed to walk away from the terms of their agreements.
While sympathetic to the respondents’ position, the Court ultimately granted the Franchisor’s request for an injunction to restrain the respondents’ breach of the restrictive covenant. The case reaffirms the Court’s view of the importance of maintaining commercial certainty by enforcing terms of agreements that parties have entered into, even where doing so may have harsh consequences to a franchisee.