Franchise agreements, distribution agreements, leases, employment contracts and numerous other commercial contracts often contain terms that try to prevent one party from competing with the other in the same or a similar business for a period of time after the contract ends.
They're called post-term restrictive covenants or non-competition clauses, and I'll use the terms interchangeably here. Unless these contracts are really – and I mean really – well drafted, they're often not worth the paper they're printed on.
Let’s start with the franchise example, because I see this all the time in my practice.
A franchisee in the pizza restaurant business, whose contract is about to end, doesn’t want to renew his franchise agreement for another five years. He's had it with the franchisor. But he's on the lease for three more years, so he can't really pack up and move away without being sued by an angry landlord. He wants to open up in the same space under a different name and trademark when the old franchise agreement ends, carry on more or less as before, and keep cooking and serving pizza.
The non-competition covenant in his franchise agreement is one short paragraph within a 40-page document. It provides that he won't, within a 50-mile radius around the current location, or any other franchised location operated by someone else, at any time during the period of five years from the date of expiration, termination or transfer, “either individually or in conjunction with or as part of any person, firm, partnership, corporation, syndicate, association, joint venture or other third party or other entity whatsoever, whether as principal, agent, shareholder, director, officer, partner, employee, consultant, member, joint venturer or guarantor or in any other manner whatsoever, directly or indirectly, carry on, be engaged in or be concerned with or interested in, financially or otherwise, or advise in the establishment or operation of a business that is similar to the franchised business under this agreement."
If I'm acting for a franchisee, I love covenants like this because it might just have said “all of North America for 30 years” or “the entire galaxy for eternity."
A restrictive covenant in a franchise agreement that tries to keep someone out the same kind of business for five years in a large chunk of the Greater Toronto Area, Metro Vancouver or other city is rarely, if ever, going to be enforceable in a Canadian court. These sorts of covenants are seen as a “restraint of trade,” and the courts, as a rule, don’t like to enforce contractual provisions that restrain trade. The covenant has to be reasonable in the circumstances to protect the legitimate business interests of the party enforcing it. It has to be limited in time and limited in geographic scope.
But in this case, 50 miles around the location (or any other location within the franchisor’s system) for five years won't be reasonable. Sorry. Game over.
Now if it had said “six months from the location the business operates from,” that might be a different story because it's not so long and not so broad in geographic scope to be blatantly unreasonable.
Let’s run with the example “six months from the current location.” If you look at the language above, and plug in the new numbers, what is our soon-to-be-former pizza restaurant franchisee actually prevented from being involved in? “A business similar to the franchised business.”
This won’t fly either. Also unenforceable.
When a covenant purports to prevent a party from being in a particular business, the language had better be totally clear and specific on the kind of business the franchisee, licensee, employee or other contracting party is being prevented from being in. And it better be reasonable. “Similar business” is too vague and too uncertain. What is a similar business? If I have to guess, so will a judge, and I can tell you, she won’t try. Sorry, game over. Again.
What if the covenant purported to restrict the former franchisee from being in the “restaurant business?” This generally won't be enforceable either, because there are various kinds of restaurants that an ex-restaurant franchisee can be involved in. And you can't deprive someone from earning a living, especially if the restaurant business is all they know. But if it had said a restaurant business where “50 per cent of food revenue was from the sale of pizza," that might be a bit more troublesome for the former franchisee who wants to open up his own pizza restaurant after her current pizza restaurant franchise ends.
But even if the covenant did describe, with much greater certainty, the kind of business the soon to be ex-franchisee was not to be in for six months, there are other hoops a franchisor or other party enforcing a restrictive covenant has to jump through to obtain an interlocutory injunction to stop the conduct right away. One of them is cost. From the perspective of legal fees alone, injunctions are phenomenally expensive for both parties, but usually more for the party seeking to enforce the covenant. The second issue is the injunction itself, because there are many factors that have to be satisfied before a court will grant such an extraordinary remedy such as an injunction before a trial. The bar is set high because granting the injunction may well decide the outcome of the trial. So the franchisor could spend truckloads of money and still lose.
There are other factors that might come into play, including any inequality of bargaining power between the parties, and whether the person at the receiving end of the injunction obtained independent legal advice before he or she entered the franchise or other contract that contained the restrictive covenant.
So if you're considering signing a franchise agreement that restricts you from being in a “similar business” when the contract ends for five years and 50 miles from your soon-to-be-franchised location, what do you do? Well, see a lawyer, because these are complicated issues, the law is different across Canada, and the facts aren’t always that simple.
But based on the facts I've given you above, I might provide what I call Basil Faulty's Advice. Whatever you do, don't mention the war. Leave it alone. Don’t touch it. Don’t bring it up.
If you let the franchisor know its restrictive covenant is too long in time, too broad in scope or too uncertain, all the franchisor will do will be to fix it to make it more enforceable against you. So just don’t mention it. Besides, if the franchisor drafted it, and the drafting is ambiguous, there's a rule of contractual interpretation that states that the ambiguity will be resolved against the party that wrote the provision. So strike three.
What if I'm the franchisor wanting to stop someone from being in the same business after the franchise agreement ends?
Well, the facts above won't help me, because if the franchisee's lawyer knows his or her law, they'll send me a recent case from the Supreme Court of Canada on non-competition covenants, and politely tell me to jump in a lake. It's over baby. Time to redraft my contract.
So you might “lawyer up” and redraft your covenant to make it more enforceable. Shorten the time period of the restriction. Make the geographic restriction smaller. Define the business more specifically. And you might put in a provision that allows the franchisor to unilaterally reduce the scope of the covenant without consent of the franchisee, just so you can reduce it further if the law changes and you have doubts about its enforceability in five years.
Or you might just concentrate on beefing up other contractual provisions that might be easier to enforce, such as non-solicitation provisions that prevent the ex-franchisee from soliciting former customers or former employees. You could beef up your confidentiality and trade secret provisions so the ex-franchisee has to significantly alter its business practices or risk breaching these provisions. You might try to contractually ensure that on termination or expiration of the franchise agreement, the franchisor can force the franchisee to assign its telephone number into the franchisor's name, forcing the franchisee to get a new one, at some inconvenience. And you could include an “option to purchase” in the franchise agreement permitting you to buy back all the ex-franchise's business assets for fair market value, forcing the ex-franchisee to buy new business assets at full price while you get all his for a song.
And if you have the lease in your name and sublet the premises to the franchisee, then you have more control over where the ex-franchisee can operate because you're his landlord under the sublease. If you don’t, a conditional assignment of the lease might allow the franchisor to take over the lease on expiration or termination of the franchise, as long as the landlord is on side.
If the ex-franchisee is breaching its contract and leaving the franchise system before the term ends, you might make use of all of the points noted above (i,f of course, you've drafted them into your contract), but instead of trying to enforce a non-competition covenant, your agreement might have a provision whereby damages are estimated based on a formula such as what the franchisor would have received in royalties per month had the franchisee not breached prematurely. If those royalties totalled $10,000 a month, the franchisee might think twice before bolting, as it may be easier for you to enforce a monetary damage claim against a renegade franchisee than a non-competition clause.
A couple of other points to think about. First, it may be easier to enforce a non-competition clause when the party trying to enforce it actually paid to keep the other side out of the business for a while. This happens regularly when a purchaser buys an existing business, but doesn’t want the vendor or the vendor's owners to set up shop across the street under a new name, and take away the business and the customers the purchaser thought it was buying. In vendor-purchaser deals, you'll often see a payment of part of the purchase price allocated to the corporate vendor and its principals as a payment for their non-competition.
But the provision still has to be reasonable in the circumstances.
Second, the comments above are general and your facts may differ, so see a lawyer if you have questions about the enforceability of a covenant you've signed, or are about to sign. This is a newspaper column, not a legal opinion.
Special to the Globe and Mail
Vancouver franchise lawyer Tony Wilson is the author of Buying A Franchise In Canada – Understanding and Negotiating Your Franchise Agreement and he is ranked as a leading Canadian franchise lawyer by LEXPERT. He is head of the Franchise Law Group at Boughton Law Corp. in Vancouver and acts for both franchisors and franchisees across Canada, many of whom are in the food services and hospitality industry. He is a registered Trademark Agent, an Adjunct Professor at Simon Fraser University and he also writes for Bartalk and Canadian Lawyer magazines.