Eliminating a competitor through the purchase of its business is a sound commercial strategy. To make it effective in the long term, or long enough to make renewed competition immaterial, the buyer will insist on a non-competition covenant as part of the transaction. The willingness of the courts to enforce them varies considerably based on the context in which the agreement was formed, and they will do so where they are reasonable in the scope and extent of the restrictions imposed. Such covenants operate against the vendor only and not against independent third parties.

If the vendor owns other properties and businesses in the non-competitive area further concerns for the vendor arise. The properties may be leased to new and independent competitors which would defeat the elimination strategy of the purchaser. One means of preventing this would be to obtain further restrictive covenants or rights of first refusal in relation to the other properties or businesses.

A Recent Case

The Ontario Court of Appeal (“ONCA”) had recently to deal with the aftermath of such a transaction in Goodlife Fitness Centres Inc. v. Rock Developments Inc. Here the vendor, Rock Developments Inc. (“RDI”), operated a competitive fitness business. Good Life Fitness Centres Inc. (“GFCI”) was to purchase the shares in the RDI operation and thereafter continue to operate a fitness centre under its own name. As part of the transaction, RDI gave non-competition covenant which restricted it from having any involvement in a competitive fitness business or from assisting or providing development services to a competitive business for five (5) years.

As RDI owned other properties and business in the restricted area it also agreed to give further restrictive covenants along the same lines in respect of two other properties. It refused to do so for a third property advising that it intended to sell the land in the near future and further that its co-owners refused to grant such a restriction. GFCI then asked for and received, a right of first refusal on this third property with respect to any offers to lease the land. The right specified that if a competing fitness business was to lease the land that GFCI could lease the land on the same terms, but if they declined to do so, then RDI could proceed with leasing the property to the competitor.

Four years later, RDI wanted to lease the third property covered by the right of first refusal to a competitive fitness centre. The transaction would involve RDI as not only the lessor but also the general contractor for the construction of a new fitness centre for the competitor.

RDI advised GFCI of its plans but GFCI declined to take up the offer as was its right. As a result, RDI went forward with its lease and development plans with the competitor. GFCI then sought a court declaration and injunction against RDI on the grounds that the new lease was void and in contravention of the non-competition clause.

Hearing Decision

The applications judge found in favour of GFCI. He relied heavily on the pre-signing negotiations to come to his decision. He found that the non-competition clause took precedence over the right of first refusal. The right of first refusal was additional protection for the purchaser. Therefore the new lease was void and an injunction was granted against RDI.

Further, the judge found that even if not paramount, the non-competition clause prohibited the very conduct that RDI was proposing being development assistance.

ONCA Analysis

The ONCA reversed the decision below finding that:

1. Without express wording in the documents making one right greater than the other, the specific right should prevail over the general right. The documents created two obligations on RDI and although both had to be observed neither was overriding of the other;
2. Secondly, they made it clear that courts should not rely on the evidentiary materials leading up to the execution of the documents as a guide to interpretation. The ONCA repeated its past decisions stating that a review of the past negotiation material which was objective was allowed as evidence of the factual matrix, however, most of such evidence is not to be used to construct an interpretation of the signed documents over their plain wording;
3. Thirdly, the judge below had in any event, misconstrued the negotiation evidence and ignored a critical letter which made it clear that the right of first refusal was a substitute for the restrictive covenant first asked for on the subject lands.

Finally, the ONCA found that there had been no contravention of the non-competition covenant. Having complied with its obligations under the right of first refusal RDI was free to proceed to lease the property to a competitor. The services it was providing were within the usual scope of those provided by a commercial landlord to its tenant. The broader restrictions in the non-competition agreement would not apply.

Takeaways

• Express language is required to make one obligation paramount over another especially where they cover the same ground;

• Evidence of the pre-contract negotiations is, for the most part, to be ignored in interpreting the plain and ordinary wording of the contractual obligations;

• This means that the drafting and review of the contractual wording in such transactions require careful and precise wording and allowed to encompass all possibilities that may occur.

If you have questions about any of the above or require additional information about non-solicitation, non-competition agreements, and non-disclosure agreements, contact the lawyers in our Employment Law Group at Duncan, Linton LLP in Waterloo.  We have been advising employers and employees for over 150 years. Call us at (519) 886-3340 or contact us online to schedule a consultation.