The recent decision Pet Valu Canada Inc. v. 1381114 Ontario Limited1 is unique because it is one of the first decisions in Canada to explicitly hold that non-competition clauses may be binding on non-arm’s length parties to a franchise agreement.
Prior to the Pet Valu decision, the courts have only discussed corporate alter egos by stating in Bark v. Fitz2 that, “If the non-competition clause did not bind the principal of the corporate franchisee, that clause would be effectively meaningless: the principal could simply start a new corporation.”
Pet Valu, therefore, takes it one step further by throwing non-arm’s length parties to the mix. In Pet Valu, the franchisee was the sole officer and director of 1381114 Ontario Limited and entered into a franchise agreement with Pet Valu that contained a non-competition clause that prohibited the franchisee from operating or participating in a competitive business for 2 years within a 20 kilometer radius of the store. However, instead of complying with the non-competition clause, the franchisee asked her husband to set up a new corporation by the name of Pet Stuff & Supplies which was located a mere 450 meters from the closest Pet Valu location.
The judge in this decision decided to enforce the non-competition covenant against the non-parties to the franchise agreement because the judge determined that the husband had set up the new corporation to hide his wife’s involvement in the competing business in order to assist her in competing with Pet Valu when she had undertaken not to do so.
The judge in this decision stated that the actions were “a transparent effort by all of the defendants to avoid the restrictive covenants” and therefore, ordered the defendants to cease operating the competing business, explaining that a “fundamental aspect of any franchise system is the protection of its method of operation, goodwill, products and services”; therefore, the defendants’ breach of their undertaking to not compete would harm the Pet Valu franchise system.
This decision demonstrates that the courts will enforce a non-competition clause on non-parties if the non-parties are non-arm’s length third parties who are operating the competing business in an attempt to assist the signatory in evading their non-competition undertakings. Therefore, potential franchisees should fully understand the non-competition provisions in their franchise agreement before signing on the dotted line.
The decision in the Pet Valu case is similar to a situation that took place about ten years ago in Hamilton, Ontario. In Bulk Barn Foods Ltd. v Faber3, the court granted an injunction restraining Faber and her company from competing with Bulk Barn following the expiration of a franchise agreement. Faber was a 50% shareholder of the franchisee company, a fact that had not been disclosed to Bulk Barn at the time the franchise agreement was signed. The franchise agreement required shareholders to give an undertaking to be bound by the non-competition covenant in the franchise agreement, but Faber never gave it. Faber had been involved with her husband in the day-to-day operation of the Bulk Barn franchise during the term of the franchise agreement. She was held to be bound by the undertaking not to compete as if she had signed it.