In our December newsletter, we wrote about the decision in MEDIchair LP v. DME Medequip Inc. where the Ontario Superior Court of Justice held that a restrictive covenant was reasonable in scope and enforceable against a former franchisee, despite the fact that the franchisor had no immediate plans to re-franchise the territory covered by the restrictive covenant. However, on appeal by the franchisee, the Court of Appeal for Ontario reversed the application judge's ruling and held that the restrictive covenant was not enforceable.
The case concerned a franchisor operating a network of franchise stores that sell and lease home medical equipment under the name MEDIchair. The franchisee, DME Medequip Inc. (DME), owned and operated the Peterborough store for approximately 20 years. In 2008, DME was acquired by two individuals through a corporation. The franchise agreement contained a post-term restrictive covenant preventing the franchisee and its principals from operating a similar store for 18 months within a 30 mile radius.
In the years leading up to the expiry of the franchise agreement, the MEDIchair franchise system was sold to a new corporate owner, which also purchased a group of 24 Motions Specialities stores. The Motions Specialties stores directly competed with the MEDIchair franchises. In particular, a Motions Specialties store in Peterborough competed with DME's franchise.
Subsequently, the franchisee became dissatisfied with the MEDIchair franchise system. When the franchise agreement expired in January 2015, the franchisee did not renew the agreement. The franchisee de-identified the store as a MEDIchair franchise, but continued to operate what was essentially the same business under the name "Living Well Home Medical Equipment."
In the decision below, the Superior Court judge granted the franchisor's application to enforce the restrictive covenant, finding that the restrictive covenant was reasonable for the benefit of the viability of the franchise system as a whole. The judge did not find that the franchisor's apparent disinterest in re-franchising the Peterborough area was a bar to enforcing the covenant. The franchisee appealed.
The primary issue on appeal was whether the franchisor was entitled to enforce the restrictive covenant when it had no intention of opening another MEDIchair store within the protected geographic area.
The Court of Appeal did not adopt the application judge's reasoning that the viability of the franchise system as a whole would be undermined if the franchisee were allowed to compete. Rather, the Court of Appeal determined that, based on the franchisor's evidence that it did not intend to operate in Peterborough, the franchisor did not have a "legitimate or proprietary interest to protect within the defined territorial scope of the covenant."
In construing the reasonableness of the non-competition covenant, the Court considered the parties' expectations at the time that the covenant was bargained for. The Court explained that "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."
The Court ultimately determined that the covenant was neither generally unreasonable nor unenforceable, but was unreasonable as between the parties in the particular circumstances of the case because the franchisor no longer had a legitimate or proprietary interest to protect within the territorial scope of the covenant.
This decision may cause franchisors to pause before seeking to enforce a restrictive covenant covering a territory that they do not plan to re-franchise. As a best practice, franchisors are encouraged to document their commercial interests in the territory and any future plans to re-franchise before potentially seeking to enforce a covenant.
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