Injunctions in Franchising: Comparing the Canadian and American Systems

1) Is there a serious issue to be tried?

2) Will the moving party suffer irreparable harm if the interim injunction is not granted?

3) Does the balance of convenience lie in favor of granting the interim injunction?

Depending on the context of the specific case, the first branch of the test ' the 'serious issue to be tried' element ' can be replaced by the more onerous strong 'prima facie case' test. For example, in the employment context, courts frequently employ the strong prima facie case test (see e.g., BMO Nesbitt Burns Inc. v. Ord, [2007] O.J. No. 2620 (Sup. Ct.). In the franchise context, when an interlocutory injunction would essentially finally decide an issue, there is some judicial debate whether the 'serious issue' threshold is raised to one of strong prima facie case.

In the United States, when considering requests for injunctive relief, the courts have established the requisite factors by case decisions. The courts weigh the following four factors:

1) Will the moving party suffer irreparable injury unless the injunction is issued?

2) Does the threatened injury to the moving party outweigh whatever damages might be caused by the requested injunction?

3) Will the injunction, if issued, be adverse to public interest or third persons?

4) Is there a substantial likelihood that the moving party will eventually prevail on the merits?

When compared with the Canadian standards, the key difference resides in the contrast between the 'serious issue to be tried' and the 'likelihood of success on the merits.'

'Serious Issue to Be Tried' vs. 'Likelihood of Success.' Generally, the first test for an interim or interlocutory injunction in Ontario is whether there is a serious issue to be tried. This threshold is quite low, and essentially the court must be satisfied upon a preliminary assessment of the merits of the case that the proceeding is neither frivolous nor vexatious.

Within the serious issue or more onerous strong prima facie case branch of the test for an interlocutory injunction, the Ontario plaintiff must also establish that there is a serious issue or strong prima facie case that the non-competition covenant is valid. This involves arguing that the non-competition covenant itself is reasonable in both geographic scope and time. Generally, the defendant (the former franchisee) will argue strenuously that the non-competition covenant is not reasonable, and this becomes a critical battleground between the parties. In Ontario, courts have upheld covenants of between one to three years as being reasonable. To be reasonable, geographic scope must be limited, be within the reasonable expectations of the parties, and generally have some connection to the geographic scope of the former franchisee's customer base. Additionally, the plaintiff must argue that there is a serious issue or strong prima facie case showing that the defendant has breached the non-competition clause.

In the United States, the closest comparable requirement is the need to establish a likelihood of success on the merits of the claims being presented. This element is strongly influenced by the proof of irreparable harm. If the balance of harms tips in favor of the moving party, the satisfaction of this element provides support for the third factor ' likelihood of success on the merits. One court has stated the linkage quite succinctly: Once the moving party has demonstrated irrevocable injury, the factor of likelihood of success on merits diminishes in importance in an equitable balancing process, 'but the requirement does not entirely fade away.' (Milwaukee Rentals, Inc. v. Budget Rent A Car Corp., 496 F.Supp. 253, 255 (E.D. Wis. 1980).) The moving party is not required to prove its likelihood of success in absolute terms.

Irreparable Harm. The second branch of the test is whether the moving party will suffer irreparable harm. Courts in both the United States and Ontario have defined irreparable harm as harm that cannot be compensated in damages. In essence, the courts will consider whether it is just to confine the plaintiff to a remedy in damages. It is important to note, however, that difficulty in proving damages must be distinguished from difficulty in measuring damages. The former fails to establish irreparable harm, while the latter is not a bar. (19 Fed. Proc., L. Ed. Injunctions and Restraining Orders '47:17 (2000).)

A traditional injunction requires a court to examine whether the plaintiff has suffered irreparable harm and whether the balance of convenience favors the plaintiff. However, the courts in Ontario have held that these elements are not required where there has been a clear breach of a negative covenant, such as a non-competition covenant (see e.g., Ontario Duct Cleaning Ltd. v. Wiles, [2001] O.J. No. 5150 (Sup. Ct).) This principle applies to both interlocutory and final injunctions, but if the court has some doubt about the merits on an interlocutory injunction, it may consider irreparable harm and balance of convenience. In cases of a clear breach of an express negative covenant, injunctive relief will ordinarily be granted without proof of irreparable harm. However, practically speaking, the court frequently will find that the moving party has proven irreparable harm regardless. As such, the plaintiff should always argue that the franchisor will suffer irreparable harm.

In the franchise context, permanent market loss, diversion of goodwill, and, most critically, the destruction of the franchise system by allowing franchises to become training grounds have all been considered irreparable harm. Court decisions in the United States support this result. Where a franchisee breaches a non-competition agreement, '[d]amage is presumed to be irreparable and the remedy at law is considered inadequate.' (The Quizno's Corporation v. Kampendahl, ' 12,335 Bus. Franchise Guide (CCH) (N.D. Ill. 2002). See also, Amerispec, Inc. v. Metro Inspection Services, Inc., ' 12,130 Bus. Franchise Guide (CCH) at 34,540 (N.D. Tex. 2001) ('injury resulting from the breach of non-compete covenants is the epitome of irreparable injury').)

The franchisor, on the other hand, should argue that the defendant will not suffer irreparable harm if the injunction is granted. Simply put, the plaintiff's position is that the defendant is being asked to abide by the contractual obligation that it willingly agreed to. Almost always, the defendant will argue that it will suffer irreparable harm. The responding party often will argue that the injunction would put it out of business and that it would be unable to provide for itself and family without the income derived from the competing business.

Balance of Convenience or Harms. The next branch of the test weighs the parties' respective harm by considering the impact on each of the parties if the injunction is granted and if the injunction is not granted. There is support for the proposition that where a contractual obligation has been breached, the balance of convenience lies in favor of the innocent party. However, courts are often sympathetic to the former franchisee, and if the injunction would result in the loss of the business at issue, they have found that the balance of convenience favors the responding party.

Public Interest. In the United States, the one additional factor considered is whether the injunction is in the public interest; and this factor can be given considerable weight. Courts are generally likely to grant injunctive relief if public policy would be furthered by such an order. In matters that merely concern private interests, public interest will not prevent the court from ordering injunctive relief to protect the moving party's clear legal rights. In many instances, the public interest has been declared in the form of a statute. Federal statutes that proscribe the type of injurious acts that are the subject of the litigation are considered to be substantial factors in favor of granting preliminary injunctive relief.

In Ontario, public interest is sometimes considered as part of the balance of convenience test if the injunction may have a public interest impact if granted. This type of analysis is more common in restrictions placed on employees after their employment has been terminated and is less
common in the franchise context.

Undertaking As to Damages/Security

In Ontario, pursuant to Rule 40.03 of the Rules of Civil Procedure, the moving party must provide an undertaking to abide by any future Order concerning damages that the court may make if it ultimately determines at trial that the granting of the injunction has caused damage to the responding party. However, the rule provides that a court can order otherwise.

In the United States, the moving party must provide actual security in an amount set by the court and in the form of a bond. The purpose of the security bond is to provide payment of damages to the party bound by the injunction or order if the injunction or order is later found to have been erroneously granted. The court retains substantial discretion to determine the amount of security and even whether to impose a bond at all. The court may forgive the security requirement if the party to be restrained shows no probability of harm. Also, courts have found that no security bond is required where the protection of enjoined parties is satisfied, such as where the moving party has sufficient financial resources to cover damages, or where the moving party lacks the financial resources to post any considerable amount in bond. The maximum amount of security required is the court's estimate of potential loss proximately caused to a party by the mistaken issuance of the injunction or order. Reasonable fees may be collected by the party erroneously enjoined up to the amount of the bond. Attorneys' fees and legal expenses, however, are generally not recoverable unless provided by statute or contract. Many franchise agreements provide that no security will be required for the issuance of a preliminary injunction. The courts, however, are not bound by that agreement, and a decision on whether security will be required, and if so the amount, is ultimately for the court.

An American Quirk

In the United States, the court has the power to advance the trial on the merits and to consolidate it with the hearing on the preliminary injunction. The advancement of the trial on the merits, however, generally cannot occur without adequate notice. But when dealing 'with purely legal issues on a fixed administrative standard ' a district court may properly reach the merits in such a case without expressly ordering consolidation under Rule 65 and without giving the parties adequate notice.' The rule provides that a court can order otherwise.

The consolidation order can be the result of a motion, or the court may order consolidation sua sponte. If the parties consent to an accelerated trial on the merits, the consent order should include the parties' agreement to preserve the status quo pending trial. (See, Michael J. Lockerby & Katherine C. Spelman, Defining and Protecting the Franchise System's Trade Secrets.)

Nonetheless, it is important to consider the strategic consequences that may follow from an expedited approach. For example, before moving for an expedited trial, a franchisor should consider that the standard for a permanent injunction is less stringent than that for a preliminary injunction. A motion for a permanent injunction does not require the display of imminence in the irreparable injury that is required in a motion for preliminary injunction. As a result, the burden placed on the movant is considerably less. Alternatively, if the case on the merits is not ripe for trial ' if the moving party would have to either sacrifice discovery to seek prompt relief or forego the application to sufficiently prepare for trial ' the court will not consolidate the trial on the merits with the preliminary injunction hearing.

In Ontario, if the moving party chooses to commence proceedings by way of an application, the court, pursuant to Rule 38.10(1)(b), may order that the matter proceed to trial. If the moving party commences proceedings by way of an action, brings a motion for an interlocutory injunction, but does not meet the burden of the three-part test, the court will refuse the interlocutory injunction and simply let the matter proceed to trial where the full merits of the case can be assessed and a final determination can be made.

Summary

In both Ontario and the United States, it is not easy to obtain an interim or interlocutory injunction for the breach of a non-competition covenant. Courts will often be sympathetic to the franchisee and his or her irreparable harm arguments. In Ontario, the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c.3, which in part codifies the common law duty of good faith and fair dealing owed by franchisors to franchisees, was recently passed, and it is perceived by the franchisors' bar that there is a bias in the courts in favor of the franchisee.

Franchisors need to ensure that they come to court with clean hands and with all their documents fully signed and sealed. It is important to ensure the non-competition clauses are reasonable in geographic scope and time. Additionally, some courts do not understand the franchise context and consider non-competition covenants to be a restraint on trade, as they are in the employment context. As such, it is important to always educate the court on the unique aspects of franchising.

The Canadian authors are Jennifer Dolman, a partner at Osler, Hoskin & Harcourt LLP in Toronto, Ontario, and Denise Sayer, an associate at Osler, Hoskin & Harcourt LLP. The U.S. author is Jon S. Swierzewski, a shareholder at Larkin Hoffman Daly & Lindgren Ltd., in Minneapolis.

This month's installment continues an exploration of the differences that franchisors in the United States and Canada will face when seeking injunctions to enforce non-competition and other covenants contained in their franchise agreements. Part One explored issues of speed of obtaining an injunction, the motion hearing and evidentiary considerations, and motion materials.

The Legal Test

In Ontario, an injunction can be granted pursuant to '106 of the Courts of Justice Act, which provides that 'a court, on its own initiative or on motion by any person, whether or not a party, may stay any proceeding in the court on such terms as are considered just.' Section 106 has been judicially developed into a three-part test:

1) Is there a serious issue to be tried?

2) Will the moving party suffer irreparable harm if the interim injunction is not granted?

3) Does the balance of convenience lie in favor of granting the interim injunction?

Depending on the context of the specific case, the first branch of the test ' the 'serious issue to be tried' element ' can be replaced by the more onerous strong 'prima facie case' test. For example, in the employment context, courts frequently employ the strong prima facie case test (see e.g., BMO Nesbitt Burns Inc. v. Ord, [2007] O.J. No. 2620 (Sup. Ct.). In the franchise context, when an interlocutory injunction would essentially finally decide an issue, there is some judicial debate whether the 'serious issue' threshold is raised to one of strong prima facie case.

In the United States, when considering requests for injunctive relief, the courts have established the requisite factors by case decisions. The courts weigh the following four factors:

1) Will the moving party suffer irreparable injury unless the injunction is issued?

2) Does the threatened injury to the moving party outweigh whatever damages might be caused by the requested injunction?

3) Will the injunction, if issued, be adverse to public interest or third persons?

4) Is there a substantial likelihood that the moving party will eventually prevail on the merits?

When compared with the Canadian standards, the key difference resides in the contrast between the 'serious issue to be tried' and the 'likelihood of success on the merits.'

'Serious Issue to Be Tried' vs. 'Likelihood of Success.' Generally, the first test for an interim or interlocutory injunction in Ontario is whether there is a serious issue to be tried. This threshold is quite low, and essentially the court must be satisfied upon a preliminary assessment of the merits of the case that the proceeding is neither frivolous nor vexatious.

Within the serious issue or more onerous strong prima facie case branch of the test for an interlocutory injunction, the Ontario plaintiff must also establish that there is a serious issue or strong prima facie case that the non-competition covenant is valid. This involves arguing that the non-competition covenant itself is reasonable in both geographic scope and time. Generally, the defendant (the former franchisee) will argue strenuously that the non-competition covenant is not reasonable, and this becomes a critical battleground between the parties. In Ontario, courts have upheld covenants of between one to three years as being reasonable. To be reasonable, geographic scope must be limited, be within the reasonable expectations of the parties, and generally have some connection to the geographic scope of the former franchisee's customer base. Additionally, the plaintiff must argue that there is a serious issue or strong prima facie case showing that the defendant has breached the non-competition clause.

In the United States, the closest comparable requirement is the need to establish a likelihood of success on the merits of the claims being presented. This element is strongly influenced by the proof of irreparable harm. If the balance of harms tips in favor of the moving party, the satisfaction of this element provides support for the third factor ' likelihood of success on the merits. One court has stated the linkage quite succinctly: Once the moving party has demonstrated irrevocable injury, the factor of likelihood of success on merits diminishes in importance in an equitable balancing process, 'but the requirement does not entirely fade away.' ( Milwaukee Rentals, Inc. v. Budget Rent A Car Corp., 496 F.Supp. 253, 255 (E.D. Wis. 1980).) The moving party is not required to prove its likelihood of success in absolute terms.

Irreparable Harm. The second branch of the test is whether the moving party will suffer irreparable harm. Courts in both the United States and Ontario have defined irreparable harm as harm that cannot be compensated in damages. In essence, the courts will consider whether it is just to confine the plaintiff to a remedy in damages. It is important to note, however, that difficulty in proving damages must be distinguished from difficulty in measuring damages. The former fails to establish irreparable harm, while the latter is not a bar. (19 Fed. Proc., L. Ed. Injunctions and Restraining Orders '47:17 (2000).)

A traditional injunction requires a court to examine whether the plaintiff has suffered irreparable harm and whether the balance of convenience favors the plaintiff. However, the courts in Ontario have held that these elements are not required where there has been a clear breach of a negative covenant, such as a non-competition covenant (see e.g., Ontario Duct Cleaning Ltd. v. Wiles, [2001] O.J. No. 5150 (Sup. Ct).) This principle applies to both interlocutory and final injunctions, but if the court has some doubt about the merits on an interlocutory injunction, it may consider irreparable harm and balance of convenience. In cases of a clear breach of an express negative covenant, injunctive relief will ordinarily be granted without proof of irreparable harm. However, practically speaking, the court frequently will find that the moving party has proven irreparable harm regardless. As such, the plaintiff should always argue that the franchisor will suffer irreparable harm.

In the franchise context, permanent market loss, diversion of goodwill, and, most critically, the destruction of the franchise system by allowing franchises to become training grounds have all been considered irreparable harm. Court decisions in the United States support this result. Where a franchisee breaches a non-competition agreement, '[d]amage is presumed to be irreparable and the remedy at law is considered inadequate.' (The Quizno's Corporation v. Kampendahl, ' 12,335 Bus. Franchise Guide (CCH) (N.D. Ill. 2002). See also, Amerispec, Inc. v. Metro Inspection Services, Inc., ' 12,130 Bus. Franchise Guide (CCH) at 34,540 (N.D. Tex. 2001) ('injury resulting from the breach of non-compete covenants is the epitome of irreparable injury').)

The franchisor, on the other hand, should argue that the defendant will not suffer irreparable harm if the injunction is granted. Simply put, the plaintiff's position is that the defendant is being asked to abide by the contractual obligation that it willingly agreed to. Almost always, the defendant will argue that it will suffer irreparable harm. The responding party often will argue that the injunction would put it out of business and that it would be unable to provide for itself and family without the income derived from the competing business.

Balance of Convenience or Harms. The next branch of the test weighs the parties' respective harm by considering the impact on each of the parties if the injunction is granted and if the injunction is not granted. There is support for the proposition that where a contractual obligation has been breached, the balance of convenience lies in favor of the innocent party. However, courts are often sympathetic to the former franchisee, and if the injunction would result in the loss of the business at issue, they have found that the balance of convenience favors the responding party.

Public Interest. In the United States, the one additional factor considered is whether the injunction is in the public interest; and this factor can be given considerable weight. Courts are generally likely to grant injunctive relief if public policy would be furthered by such an order. In matters that merely concern private interests, public interest will not prevent the court from ordering injunctive relief to protect the moving party's clear legal rights. In many instances, the public interest has been declared in the form of a statute. Federal statutes that proscribe the type of injurious acts that are the subject of the litigation are considered to be substantial factors in favor of granting preliminary injunctive relief.

In Ontario, public interest is sometimes considered as part of the balance of convenience test if the injunction may have a public interest impact if granted. This type of analysis is more common in restrictions placed on employees after their employment has been terminated and is less
common in the franchise context.

Undertaking As to Damages/Security

In Ontario, pursuant to Rule 40.03 of the Rules of Civil Procedure, the moving party must provide an undertaking to abide by any future Order concerning damages that the court may make if it ultimately determines at trial that the granting of the injunction has caused damage to the responding party. However, the rule provides that a court can order otherwise.

In the United States, the moving party must provide actual security in an amount set by the court and in the form of a bond. The purpose of the security bond is to provide payment of damages to the party bound by the injunction or order if the injunction or order is later found to have been erroneously granted. The court retains substantial discretion to determine the amount of security and even whether to impose a bond at all. The court may forgive the security requirement if the party to be restrained shows no probability of harm. Also, courts have found that no security bond is required where the protection of enjoined parties is satisfied, such as where the moving party has sufficient financial resources to cover damages, or where the moving party lacks the financial resources to post any considerable amount in bond. The maximum amount of security required is the court's estimate of potential loss proximately caused to a party by the mistaken issuance of the injunction or order. Reasonable fees may be collected by the party erroneously enjoined up to the amount of the bond. Attorneys' fees and legal expenses, however, are generally not recoverable unless provided by statute or contract. Many franchise agreements provide that no security will be required for the issuance of a preliminary injunction. The courts, however, are not bound by that agreement, and a decision on whether security will be required, and if so the amount, is ultimately for the court.

An American Quirk

In the United States, the court has the power to advance the trial on the merits and to consolidate it with the hearing on the preliminary injunction. The advancement of the trial on the merits, however, generally cannot occur without adequate notice. But when dealing 'with purely legal issues on a fixed administrative standard ' a district court may properly reach the merits in such a case without expressly ordering consolidation under Rule 65 and without giving the parties adequate notice.' The rule provides that a court can order otherwise.

The consolidation order can be the result of a motion, or the court may order consolidation sua sponte. If the parties consent to an accelerated trial on the merits, the consent order should include the parties' agreement to preserve the status quo pending trial. (See, Michael J. Lockerby & Katherine C. Spelman, Defining and Protecting the Franchise System's Trade Secrets.)

Nonetheless, it is important to consider the strategic consequences that may follow from an expedited approach. For example, before moving for an expedited trial, a franchisor should consider that the standard for a permanent injunction is less stringent than that for a preliminary injunction. A motion for a permanent injunction does not require the display of imminence in the irreparable injury that is required in a motion for preliminary injunction. As a result, the burden placed on the movant is considerably less. Alternatively, if the case on the merits is not ripe for trial ' if the moving party would have to either sacrifice discovery to seek prompt relief or forego the application to sufficiently prepare for trial ' the court will not consolidate the trial on the merits with the preliminary injunction hearing.

In Ontario, if the moving party chooses to commence proceedings by way of an application, the court, pursuant to Rule 38.10(1)(b), may order that the matter proceed to trial. If the moving party commences proceedings by way of an action, brings a motion for an interlocutory injunction, but does not meet the burden of the three-part test, the court will refuse the interlocutory injunction and simply let the matter proceed to trial where the full merits of the case can be assessed and a final determination can be made.

Summary

In both Ontario and the United States, it is not easy to obtain an interim or interlocutory injunction for the breach of a non-competition covenant. Courts will often be sympathetic to the franchisee and his or her irreparable harm arguments. In Ontario, the Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c.3, which in part codifies the common law duty of good faith and fair dealing owed by franchisors to franchisees, was recently passed, and it is perceived by the franchisors' bar that there is a bias in the courts in favor of the franchisee.

Franchisors need to ensure that they come to court with clean hands and with all their documents fully signed and sealed. It is important to ensure the non-competition clauses are reasonable in geographic scope and time. Additionally, some courts do not understand the franchise context and consider non-competition covenants to be a restraint on trade, as they are in the employment context. As such, it is important to always educate the court on the unique aspects of franchising.

The Canadian authors are Jennifer Dolman, a partner at Osler, Hoskin & Harcourt LLP in Toronto, Ontario, and Denise Sayer, an associate at Osler, Hoskin & Harcourt LLP. The U.S. author is Jon S. Swierzewski, a shareholder at Larkin Hoffman Daly & Lindgren Ltd., in Minneapolis.