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Restrictive Covenants – Not as binding as they may appear to be
MEDIchair LP v. DME Medequip Inc., 2016 ONCA 168
Contracts, whether in a commercial or employment context, sometimes employ the use of restrictive covenants (such as non-compete and non-solicitation clauses) to protect business owners and employers. Violating the restraints imposed by a covenant may result in damages ordered against employees and business operators/purchasers. However, as MEDIchair LP v DME Medequip Inc. demonstrates below, in certain circumstances, a covenant may be found to be unenforceable.
MEDIchair is a franchisor of stores that sell and lease home medical equipment. It entered into a franchise agreement with DME Medequip Inc. (“DME”), which has operated a MEDIchair franchise store in Peterborough, Ontario for 20 years. The two parties signed their latest franchise agreement in 2005. In the agreement, a restrictive covenant prevents DME from operating a similar store for 18 months within a 30-mile radius of their store or of another MEDIchair franchise store.
In 2011, MEDIChair was sold to Centric Health Corporation (“Centric”). Centric also bought Motion Specialties (“Motion”) and other stores that are similar to MEDIchair stores. To the disillusionment of DEM, Centric began to offer more support to MEDIchair’s competitor store, Motion, in Peterborough. The number of MEDIchair stores eventually declined, and Centric decided to transfer the ownership of both MEDIchair and Motion to Birch Hill Equity Partners in 2014.
As DEM was unhappy with the way Centric has favoured its competition, it decided not to renew the franchise agreement with MEDIchair in 2015. DEM removed all MEDIchair signage and began operating under a new name, Living Well Home Medical Equipment. However, it was essentially the same business in the same location, selling the same products, and employing the same workers.
MEDIchair filed an application to court to stop DME from carrying on business, claiming DME is bound by the non-compete clause in the franchise agreement. DME argued that the restrictive covenant was not enforceable and that there was no breach of the franchise agreement. However, the application Judge found the clause enforceable and that DME breached the agreement. DME appealed the decision of the application Judge.
Issue on the Appeal
Should the non-compete covenant be enforced, preventing DME from carrying on business against MEDIchair?
The learned Justice Feldman based his analysis on a number of cases that look at restrictive covenants in both the context of employment contracts and business sales contracts. A convenant is a restraint on trade that is inherently contrary to the public interest. Case law dictates that restrictive covenants are enforceable only if it is reasonable to both parties and it takes into consideration the public interest. There is a higher burden in the employment context than in the sale of business.
It would be contrary to the public interest for a business owner to sell its business and then have the purchaser compete with that same business. At the same time, the covenant cannot restrict the purchaser from operating a business in a territorial scope that is too large for a timeframe that is too long, thereby causing economic hardships for the purchaser.
Although time and territorial restrictions are usually the main factors to consider in matters involving non-compete covenants, the circumstances in this case are different in that the operator of business, DEM, is staying within same geographical location of Peterborough instead of operating elsewhere. The question was not whether DEM was operating too closely to its former franchisor, MEDIchair, but rather if MEDIchair has a legitimate business interest in Peterborough for DEM to compete with to merit protection through the non-compete clause:
37 Although this case involves a restrictive covenant in a franchise agreement, I do not need to decide what level of scrutiny properly applies, because the focus of the inquiry is not the reasonableness of the extent of the temporal or territorial restrictions. Instead, it is whether there is a legitimate interest of the franchisor in this case that is entitled to the protection of the covenant. The requirement of a legitimate protectable interest is common to both levels of scrutiny (emphasis added)
Considering MEDIchair did not intend to have a store in the Peterborough area, it had no business interest to protect in the same territory as DME. Furthermore, MEDIchair did not claim that enforcing the restrictive covenant is for the purpose of protecting the Motion stores owned by the same corporate group. As a result, Judge Feldman decided in favour of the appellants and overturned the original ruling.
The most common restrictive non-compete covenants typically deal with the issue regarding how far the employee or business purchaser is from the employer or seller’s location. This case poses an additional question – does the employer or covenant-enforcer have a legitimate business interest to protect? If not, then the restrictive covenant may not be enforceable.
Although this is a case that focuses on restrictive covenants in the context of sale of businesses, the same principles may still apply to an employment relationship. An employee may find it difficult to seek comparable positions if they are bound by a restrictive covenant imposed by former employer who may not have a legitimate business interest to protect. Courts will give even greater scrutiny and hold employers to higher standards than in the business context.
If you are an employee dealing with a restrictive covenant and wish to question its validity, it is important to seek legal advice to ensure you are protected. Contact Monkhouse Law today for a free consultation regarding similar and other employment law issues.
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