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How to Properly Draft Restrictive Covenants (Non-compete Provisions) in Franchise Agreements
Restrictive covenants, or more commonly referred to as non-compete clauses in franchise agreements, are contractual provisions that attempt to prohibit a franchisee from utilizing the knowledge or expertise that they have acquired from a franchisor for the purpose of operating a competing business following the expiration or termination of a franchise agreement. For a franchisor, the importance of enforcing a restrictive covenant post-termination of a franchise agreement is to prohibit franchisees from using the franchisor’s proprietary information in the operation of a business that could compete with or negatively impact the franchise system.
Although the underlying purpose of a non-complete clause may be regarded as legitimate, Canadian courts have had to balance the freedom of parties to enter into these contracts against restrictions on trade. This has led to court decisions that have set out several principles, that if followed, can help to ensure that restrictive covenants in franchise agreements will be deemed enforceable.
How do You Properly Draft Restrictive Covenants?
In general, non-compete provisions are presumptively unenforceable, unless such covenants are determined to be reasonable. The reasonableness of a restrictive covenant is reviewed under certain qualifications: protection of the legitimate proprietary interest of the franchisor, the geographic scope, temporal scope, and the use of clear unambiguous language.
First, the franchisor must establish that it has a proprietary interest in which it is seeking to protect. In essence, they must demonstrate: i) what makes the franchisor’s product or business unique; ii) why the franchisor requires protection and; iii) what is at stake for the franchisor if the protection is not granted. Typically, franchisors will be deemed to have proprietary interests in specific trade secrets, recipes, and techniques, as well as other confidential or proprietary information, including knowledge of the franchisor’s customer base.
When non-compete provisions are drafted to protect nonspecific proprietary interests it may be difficult for a franchisor to demonstrate that they have developed a unique franchise system that requires protection from duplication.
Temporal and Spatial Scope
The length of time that a departing franchisee will be subject to a post-termination non-competition covenant, and the size of the area in which the departing franchisee cannot compete, are both restrictions that must be limited to only what is reasonable and necessary to adequately protect the franchisor’s proprietary interest. A restrictive covenant that is too long or covers too large of an area will likely be found to be unreasonable.
In most cases, courts have found restrictive covenants to be reasonable if they extend for up to two years. Longer non-competition provisions can be enforceable, but will often require more extensive justifications, such as demonstrating the highly specialized nature of the franchisor’s business activities.
The geographic scope of a restrictive covenant is more likely to be the cause of non-enforceability issues. Courts have generally agreed that restrictive covenants should be drafted to ensure that such restrictions only cover the actual or intended market territories of the franchisor or other franchises.
Restrictive covenants should be drafted in clear and unambiguous language. A leading case on ambiguity in restrictive covenants comes from British Columbia, where the non-compete provision defined the geographic scope as the “Metropolitan City of Vancouver”1. In this case, the Supreme Court of Canada refused to enforce the restrictive covenant due to its ambiguity, as the “Metropolitan City of Vancouver” is not a defined term or a distinct georgraphic area. Of significance, the Supreme Court ruled that courts should not employ the doctrine of the “blue pencil severance” to attempt to rewrite or read down unenforceable provisions in order to make such provisions enforceable. This decision demonstrates that courts will not be overly flexible when interpreting restrictive covenants, as the parties drafting the contract have an obligation to ensure that the covenants are clearly defined.
If you have any questions on restrictive covenants, we encourage you to reach out to one of the members of our franchise legal team to assist with the preparation of restrictive covenants in your franchise agreement.
This article was written by Business and Franchise Lawyer Ashley Caldwell and Articling Student Skylar Oldreive. If you require assistance with a franchise and intellectual property law matter or wish to speak to a franchise lawyer at McKenzie Lake Lawyers LLP, please call (519) 672-5666.