Can I Protect My Secret Sauce? – The Enforceability of Restrictive Covenants for a Pizza Franchise [BC1]

Xiyuan Feng Blog

Written by Xiyuan Feng, supervised by Professor Bruce Curran

During the term of a franchise agreement, the franchisor shares with the franchisee many business secrets, such as secret recipes, customer preferences, and the operating system that earns market share and provides profit. When the franchise agreement has expired or terminated, the franchisor faces a substantial risk that these secrets will be appropriated by the franchisee for its sole benefit. To protect itself, a franchisor often insists on having restrictive covenants in the franchise agreement during and after the contractual term: the non-competition clause, restricting the franchisee’s ability to establish a business that competes with the franchise; and/or the non-solicitation clause, under which the franchisee is prohibited from diverting franchise customers to any competitor. However, due to the restrictions such clauses place on free competition in the marketplace and free movement of businesspeople, courts deal cautiously with their enforceability and the granting of remedies like injunctions for their breach. The Supreme Court of British Columbia in the recent case of RFSP Equipment v Singh refused to grant injunctions against franchisees who established competing businesses, despite ruling that the franchisees had breached enforceable restrictive covenants.[1]

The plaintiffs in this case were the operating arms of Freshslice Pizza (“Freshslice”), a chain of pizza restaurants in British Columbia, who had franchise agreements with Mr. Singh and his corporation since 2016[2], as well as with Mr. Kanagarajah and Mr. Kanagaratnam and their corporations since 2011[3] (collectively referred to as “Defendants”). Yet, in April 2021, Singh rebranded his Freshslice restaurants as HellCrust Pizza[4] operating under his own corporation.[5] Two months later, Kanagarajah and Kanagaratnam also rebranded their Freshslice restaurants, calling them Yummy Slice Pizza, and carried on business as a sole proprietorship registered under Kanagarajah’s name.[6] Freshslice thereafter commenced actions against the Defendants alleging the breach of the restrictive covenants in the franchise agreements and seeking injunctive relief restraining the Defendants from carrying on their businesses at their current locations or within five kilometres of the locations or any other Freshslice restaurant. The plaintiff also sought damages.[7]

To determine the enforceability of the restrictive covenants in this case, the court assessed whether the clauses were unambiguous and reasonable. The court relied on the principles established in the seminal Supreme Court of Canada case of Shafron v. KRG Insurance Brokers (Western) Inc.[8], which were accurately stated as follows:

  1. Restrictive covenants are in restraint of trade and void for public policy reasons unless the restrictive covenant is reasonable; 
  2. The party seeking to enforce a restrictive covenant has the onus to show that its terms are reasonable;
  3. An ambiguous restrictive covenant will be prima facie unenforceable; and
  4. The reasonableness of a restrictive covenant depends on the geographic coverage of the covenant and the period of time in which it is effective. The extent of the activity sought to be prohibited is also relevant. [9]

While Shafron was an employment law case, the principles are still applicable to the case at bar, because both cases deal with restrictive covenants agreed to by parties with substantial disparities in their bargaining power.[10] In assessing ambiguity, the court did not buy the Defendants’ argument that a missing word meant the clauses were ambiguous, and ruled that a reasonable person would know the intention of the clauses based on the words used or through the context (e.g., the nature of franchise relationship and the agreement headings).[11] In assessing reasonableness, the Court analyzed the covenants’ scope of activity, geography and timing and found the restraints reasonable.[12] The Defendants were only prohibited from featuring pizza and other Italian food items, the products that Freshslice sells, to which its legitimate interests adhere.[13] With respect to the scope of geography, that is, 5 km from any Freshslice location, it is a reasonable distance for protecting a restaurant that predominantly sells take-out pizza.[14] Furthermore, maintaining the restrictions as such during the contractual term and for a period of two years thereafter was reasonable considering that decisions of the courts recently upheld the restrictive clauses for periods of up to two years.[15]  Therefore, the restrictive clauses in this case were enforceable and were breached by the Defendants’ rebranding.[16]

However, even though the clauses were enforceable, the Court did not grant injunctive relief since it did not find irreparable harm caused by the breaches, and the balance of convenience was in favour of the Defendants. Freshslice claimed that rebranding restaurants harmed its goodwill, reputation[17] and system[18] by confusing its customers, disclosing its operating system and food recipes to competitors, soliciting the other Freshslice franchisees to rebrand, and taking away the carefully selected locations and eroding the market share attached to these locations. Yet, the Court concluded that the Defendants’ brands are clearly distinct from Freshslice, which very few customers would confuse with Freshslice restaurant.[19] In addition, the Defendants did not use Freshslice’s ingredients or suppliers in making their products nor were other Freshslice franchisees influenced by the conduct of rebranding.[20] Thus, Freshslice’s reputation, goodwill and system were not impacted by rebranding. Although the Court found loss of sales, it ruled that this can be compensated for in damages.[21] Therefore, according to the Court, no irreparable harm was imposed on Freshslice.

As for the balance of convenience, the Defendants would default on outstanding loans and monthly rent, if the injunctions were granted.[22] Their employees would also be laid off.[23] In contrast, the suffering of Freshslice can be recoverable by an award of damages.[24] In the result, the Court refused to grant injunctions.[25]

This decision reflects the role of common law courts as protectors of liberty in society.[26] Judges are very reluctant to enforce the restraints in trade by granting injunctive relief unless there is a very good and compelling reason.[27]

[1] RFSP Equipment v Singh, 2022 BCSC 538.

[2] Ibid at para 4.

[3] Ibid at para 6.

[4] Ibid at para 16. Yes, you read that correctly: “HellCrust Pizza”.  No, I’m not making that up.

[5] Ibid at para 5.

[6] Ibid at paras 19-20.

[7] Ibid at paras 22-23.

[8]Shafron v. KRG Insurance Brokers (Western) Inc., 2009 SCC 6 [Shafron].

[9]Ibid at para 36 [citations omitted].

[10] For an excellent discussion of restrictive covenants in the employment law context, see Stacey Reginald Ball, Canadian Employment Law (Toronto: Thomson Reuters Canada, 1996, loose-leaf), ch 7 at sections 7:12; and 7:16-7:18. Online: WestlawNext Canada (date accessed 26 June 2022).

[11] Ibid at para 41.

[12] Ibid at para 45.

[13] Ibid at para 49.

[14] Ibid at paras 46-47.

[15] Ibid at para 48.

[16] Ibid at para 51.

[17] Supra note 1, at para 74.

[18] Ibid at paras 84, 90 and 92.

[19] Ibid at para 81.

[20] Ibid paras 84-89.

[21] Ibid at para 93.

[22] Ibid at para 98.

[23] Ibid at para 100.

[24] Ibid at para 102.

[25] Ibid at para 106.

[26] Supra note 11 ch 7 at section 7:1.

[27] Ibid.

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