In MEDIchair LP v. DME Medequip Inc. ("MEDIchair"), the Ontario Superior Court of Justice (the "Court") considered whether a restrictive covenant contained in a franchise agreement is enforceable by a franchisor, MEDIchair LP (the "Franchisor") against its corporate franchisee, 2169252 Ontario Inc. ("216") and its two principals, Allison Rolph and Ron Seiderer (collectively, the "Respondents").The Court also considered circumstances where a franchisor may rely on the exemption set forth in Section 5(7)(a)(iv) of the Arthur Wishart Act (Franchise Disclosure), 2000 (the "Act") to avoid the disclosure obligations set forth in the Act. Please see the following links for our previous blogs discussing other cases on these two issues:
- http://www.consumerretailadvisor.com/2015/04/fdd-exemptions-in-canadian-franchise-legislation-court-confirms-narrow-application/; and
In summary, the Court held that the Franchisor played only a passive role in the buy/sell transaction and was therefore exempt from the requirement to deliver a disclosure document to the purchaser. As a result, the fact that the franchisor decided to deliver a disclosure document to the purchaser that may have been materially deficient was legally irrelevant to the inquiry. Moreover, the Court enforced the restrictive covenant.
In MEDIchair, the Franchisor operated a network of franchisees that sold and leased a line of home medical equipment. Two of the Respondents, Allison Rolph and Ron Seiderer, purchased the shares of a company ("DME") that had been operating as a franchisee of the Franchisor for approximately 20 years in Ontario (the "Purchase Transaction") and caused 216 to continue the business of DME in Ontario. As part of the Purchase Transaction, the Respondents agreed to a restrictive covenant with the Franchisor that, for a period of 18 months after the termination of the applicable franchise agreement with the Franchisor (the "Agreement"), they would not operate any kind of business that was "similar to" the business carried on by the Franchisor or any of its franchisees within a radius of 30 miles of the nearest system outlet or the premises of 216.
Upon expiry of the Agreement, 216 changed its operating name and continued its business at the same premises, with the same merchandise and with the same employees. The Franchisor brought an application to enforce the restrictive covenant in the Agreement against the Respondents and the Respondents countered by arguing that the restrictive covenant was not enforceable because the Franchisor had breached its disclosure obligations in the Act by providing a deficient franchise disclosure document (because it did not include a copy of the Agreement). They also argued that the restrictive covenant was either ambiguous or unreasonable in temporal or spatial scope.
The Court rejected each of the arguments of the Respondents and upheld the application of the Franchisor. The Court ruled that the Franchisor was not required to provide a disclosure document to the Respondents pursuant to Section 5(7)(a)(iv) of the Act since the Franchisor had very little involvement in the Purchase Transaction. In particular, the Court noted that even if a franchisor provides a disclosure document to a franchisee, this is not determinative of whether a franchisor is required to provide a disclosure document to a franchisee pursuant to the Act.
In addition, the Court noted that the restrictive covenant was not ambiguous and was not unreasonable in temporal or spatial scope. First, courts regularly enforce restrictive covenants that contain a "similar to" reference and, on the facts of this case, 216 did not change any aspect of its business after the expiry of the Agreement which made it easier for the Court to conclude that its business was "similar to" the business carried on by the Franchisor. Further, the mere fact that a franchisor offers a range of products, not all of which are available at every franchise, does not result in an ambiguity based on the wording of such a restrictive covenant. Second, the temporal (18 months) and spatial (30 mile radius) terms of the restrictive covenant were not unreasonable since they were in line with earlier jurisprudence and, interestingly, was less restrictive than the restrictive covenant of 5 years and 100 kilometers negotiated between the Respondents with the sellers of DME in connection with the Purchase Transaction. While this was not determinative of the issue, it did suggest to the Court what the Respondents thought a reasonable restrictive covenant was in a commercial transaction. Third, the Court noted that it was not relevant whether the Franchisor would be opening a new franchise within the spatial scope covered by the restrictive covenant or that its business had been in decline; instead, the integrity of both the franchise system and the bargain struck by the parties to the Agreement should be maintained.
MEDIchair presents a number of important takeaways for franchisors. Courts are willing to find that disclosure is not required pursuant to Section 5(7)(a)(iv) of the Act as long as a franchisor is truly playing a passive role in the grant of a franchise from one party to another. Further, depending on the facts, courts may enforce restrictive covenants in a franchise setting even if they contain "similar to" provisions or if the spatial and temporal scope of the restrictive covenant is 30 miles and 18 months, respectively.
Nevertheless, franchisors should be cognizant of the factual matrix that informs a court's determination in each case. Notably, in this case, the Respondents continued to sell the same products, in the same premises, with the same employees and had entered into an even more restrictive covenant with the former sellers of DME which placed the legitimacy of their own arguments against the Franchisor under greater scrutiny.
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