It is common for an agreement for the purchase and sale of a business to contain terms restricting the future ability of the vendor to compete with the company that is sold. The intent of such a restrictive covenant is generally to protect the goodwill associated with the business. This spring, Ontario’s Court of Appeal considered the enforceability of such a clause in the context of the purchase and sale of a dentistry practice. The comments of the Court are a helpful review of the principles generally applicable to non-competition clauses within a business sale.
The agreement in Dr. C. Sims Dentistry Professional Corporation v. Cooke concerned the purchase by Dr. Sims (the buyer), through his corporation, of all of the shares of a dentistry practice owned by Dr. Cooke (the seller). The seller had operated his practice in Hamilton since 1987. He agreed to work at the purchased practice for at least two years, subject to early termination. The agreement of purchase and sale contained a provision restricting him from practicing dentistry or permitting his name to be used in such a practice for five years following his association with the purchased practice. The restriction applied to the seller’s activities “within a radius of 15 km” of the location of the purchased practice.
About two years after the sale, the buyer gave notice of his intention to terminate their association. Not long after, through his lawyer, the seller communicated his intention “to work at a dental practice 3.3 km away” from the purchased practice, as he took the position the non-competition provision was unenforceable. After the seller began working at the other dentistry practice, the buyer sued and obtained an interlocutory injunction. The seller subsequently stopped working at the nearby practice and instead began working at a practice in Simcoe.
At trial, the non-competition provision was deemed enforceable, with the trial judge finding that the duration and geographic scope of the covenant were reasonable. The seller appealed this particular finding, arguing that the trial judge had erred in “suggesting that [the seller] had the onus of proving that the non-competition covenant was unreasonable.”
In discussing the burden of proof that applies when considering the enforceability of a restrictive covenant, the trial judge in the Cooke case referenced an earlier Supreme Court of Canada decision in Payette v. Guay Inc. That case concerned whether a restrictive covenant was part of an employment contract and, therefore, subject to provisions of the Quebec Civil Code. That Code put the onus on the employer to prove the reasonableness of the clause and limited the employer from relying on such a clause in specific contexts. The Court in Payette recognized the laws relating to restrictive covenants “differ depending on whether the covenants are linked to a contract for the sale of a business or to a contract of employment” (as summarized in Cooke).
The Court in Payette also observed, “the common law rules for restrictive covenants relating to employment do not apply with the same rigour or intensity where the obligations are assumed in the context of a commercial contract.” As a result, the Ontario Court of Appeal in Cooke emphasized that in the context of commercial transactions, restrictive covenants “which are intended to protect a purchaser’s interest in the goodwill of the acquired business” should be less scrutinized than restrictive covenants used in the employment context.
According to the Court, courts should only set aside restrictive covenants contained in business agreements in “exceptional cases”, as these covenants are agreed upon by “two competently advised parties with equal bargaining power.”
The Court in Cooke referenced the fact that the two dentists had been represented by legal counsel and had equal bargaining power. Further, the restrictive covenant was agreed upon in a commercial context, and the seller’s lawyer hadn’t raised any concerns with the non-competition clause when the transaction was concluded. As a result, the Court of Appeal found the trial judge was correct in determining that the clause was presumptively legal.
In considering the reasonableness of the non-competition clause, the Court of Appeal observed that the purpose of such a clause is to protect the business’s goodwill from being devalued by the seller’s actions. The Court noted that “goodwill” includes not only the existing customer base but also the buyer’s ability to attract new patients from the area served by that business.
The Court of Appeal noted the trial judge’s finding that the five-year duration stipulated in the restrictive covenant recognized that a patient requires several visits to a new dentist before building a “trusting relationship” with them, and for those who only go to a dentist annually, it would take “a long time” to build that relationship. Accordingly, the Court did not find that, in the circumstances, the restrictive covenant was unreasonable in duration.
The seller argued the trial judge failed to consider the valuation of the business and, therefore, should not have held the geographic scope of the non-competition clause was reasonable. The Court of Appeal, referencing the Payette case, explained the general rule is that restrictive covenants should only apply to the territory in which the business operates as of the date of the sale. The seller submitted the restrictive covenant, which included areas unconnected to the business’s services.
The Court of Appeal disagreed, finding the trial judge had adequately focused on the marketplace of the purchased practice and had found that a 15 km radius “had been considered appropriate in other cases involving dental practices.” For these reasons, the Court dismissed the appeal.
Disagreements during the purchase or sale of a business can substantially disrupt a company’s operations or reputation. At Milosevic & Associates, our skilled corporate commercial litigation lawyers have extensive experience in a wide range of complex business disputes. We are adept at handling large, intricate matters with voluminous documentary disclosure as well as smaller, more streamlined cases.
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