E-Reviews

Advertising & Marketing Review

May 2008

Case Law Review

Content to follow:

 Competition Tribunal Upholds Constitutional Validity of “Adequate and Proper Test”

By Meredith Ashton

On September 11, 2006 the Commissioner of Competition (the Commissioner) filed a notice of application with the Competition Tribunal for an order against Imperial Brush Co. Ltd. and Kel Kem Ltd. (Imperial). The Commissioner alleged that Imperial had engaged in reviewable conduct pursuant to s. 74.01(1)(b) of the Competition Act (the Act). That section requires public representations about the performance, efficacy or length of life of a product to be based on adequate and proper testing. The Commissioner claimed that Imperial made unsubstantiated representations to the public that four of the company’s chimney cleaning and creosote conditioner products (a spray, powder and two fireplace logs) could clean or assist in cleaning chimneys; reduce, remove, condition, inhibit or otherwise affect the build-up of creosote (a potentially hazardous substance known to cause chimney fires); and prevent (or help to prevent) chimney fires. Additionally, Imperial claimed that the creosote conditioners were non-corrosive and non-combustible or non-toxic.

Adequate and Proper Test

The Commissioner asserted that, due to the nature of the products, Imperial should have employed the scientific method approach to discharge the adequate and proper test requirement. Counsel for Imperial argued that the company had satisfied the requirement through research and in-house testing “in a way that [was] as close to the way in which [the products would] be used.” The Tribunal concluded that the definition of an ‘adequate and proper’ test is case-specific, depending in large part on the nature and impression of the claim made.

However, given the dangerousness of chimney fires, the Tribunal stated that Imperial should be held to a high standard of testing and analysis so that the test clearly demonstrates the desired effect is reliable and not a chance result. In this specific case, the Tribunal formulated a non-exhaustive ‘adequate and proper’ test requiring, among other things, that testing “be reflective of the risk or harm which the product is designed to prevent or assist in preventing.” The Tribunal found that Imperial had failed to conduct the adequate and proper testing necessary to make the performance and efficacy claims about its four chimney cleaning and creosote conditioner products and was thus in contravention of s. 74.01(1)(b).

Constitutionality of Section 74.01(1)(b)

As part of Imperial’s defence, the company asserted that the s. 74.01(1)(b) unjustifiably infringed the right to freedom of expression as guaranteed by s. 2(b) of the Canadian Charter of Rights and Freedoms (the Charter). This type of defence had succeeded two years earlier in Commissioner of Competition v. Gestion Lebski Inc. et al. (Gestion). In that case, the Tribunal declared s. 74.01(1)(b) of the Act inoperative because the section unreasonably restricted a type of constitutionally protected commercial speech: untested, but potentially accurate, advertising. As the Supreme Court of Canada has held freedom of expression to include commercial speech such as advertising, the Tribunal in the present case conceded that s. 74.01(1)(b) of the Act infringed s. 2(b) of the Charter.

However, unlike in Gestion, the Commissioner successfully established that the Charter infringement was reasonable and demonstrably justified under s. 1 of the charter as it achieved a constitutionally valid objective – that being “the protection of consumers, competitors, and the proper functioning of the market from harm caused by unsubstantiated representations about the performance, efficacy or length of life of a product.” in a way that is reasonable and demonstrably justified. During its analysis, the Tribunal gave weight to the fact that the products were inherently dangerous and the infringed speech at issue – unsubstantiated information about a product’s performance and efficacy used for advertising purposes – is not a core value protected by s. 2(b) of the Charter. Noting that it was not bound as a matter of precedent by the Gestion decision, the Tribunal concluded that, while s. 74.01(1)(b) of the Act infringes s. 2(b) of the Charter, the interference is justified in a free and democratic society in accordance with s. 1 of the Charter and, thus, remains operative. 

 Court Confirms Non-competition Covenants Never Presumed to be Enforceable

By G. Lee Muirhead

In its November 2, 2007 decision in W. A. Bakery Franchising Ltd. v. Canam Advertising Ltd and Raphi Shram (WA Bakery), the Ontario Superior Court of Justice addressed the issue of the enforceability of a post-term non-competition covenant and the standard to be applied in deciding whether to grant an interlocutory injunction.

The court refused to enforce a non-competition covenant in a franchise agreement against a former franchisee. The decision turned largely on the enforceability and application of the covenant. Discussing these issues in the context of the standard to be applied in injunction applications, the court held that the franchisor had failed to show a clear case of breach and, therefore, was required to show irreparable harm, which it had also failed to do.

Standard in Interlocutory Injunction Application

In W. A. Bakery, the franchise agreement had expired and the former franchisee continued to operate a similar business under a different name and at the same location. Relying on a line of prior cases that established that where there is a breach of a negative covenant, irreparable harm is presumed and the franchisor argued that it should not have to show irreparable harm. Mr. Justice H.J. Wilton-Siegel, however, stated that this standard only applied where there was a “clear breach” of a negative covenant. Such a covenant did not exist in W. A. Bakery because the enforceability of the negative covenant was in issue, particularly after the expiration of the agreement.

Since there was not a clear breach of the covenant, the court held that the applicable test on the injunction application was a three-part test -- namely, that there be a serious issue to be tried; irreparable harm; and the balance of convenience favouring the injunction.

Serious Issue To Be Tried

Generally, courts will not enforce non-competition covenants unless they are reasonable in duration, geographic scope and scope of prohibited activities. In W. A. Bakery, the non-competition covenant was structured to provide for a maximum duration of 5 years. The duration was to be reduced to 4 years if 5 years was found to be unenforceable and, similarly, to 3 years,  2 years and  1 year, in each case, if the previous time period was found to be unenforceable.  Likewise, the geographical area was to be reduced in increments from 50 miles from the location to 5 miles, if the previous increment was found to be unreasonable.  The court found  the respondents’ arguments to be reasonably strong. The respondents argued that the covenant in question was unenforceable because it was too vague or, alternatively, because it was contrary to public policy (since franchisees might comply with longer and more expansive prohibitions that were unreasonable rather than pay to litigate).

The respondents also argued that the non-competition covenant operated only if the agreement was terminated and not if it expired. The court also found this argument to be of considerable force, given that the covenant only mentioned termination and not expiration, while other provisions of the agreement mentioned both termination and expiration.

However, the court also found that because the threshold for a serious issue to be tried is not a high one, the threshold had been satisfied.

Irreparable Harm

The case, therefore, turned on whether the franchisor had established irreparable harm. The franchisor asserted that if the respondents were allowed to continue to operate, the integrity of the system would be impaired because other franchisees would be more likely not to renew and prospective franchisees would be less likely to enter into agreements. Mr. Justice Wilton-Siegel found that the franchisor had submitted no evidence of similar action being taken or threatened by other franchisees, or of prospective franchisees deciding not to enter into franchise agreements as a result of the respondents' actions. Therefore, the court found this ground of alleged harm, as well as the alleged loss of goodwill, to be speculative at the present time.

Balance of Convenience

The court also found the balance of convenience favoured the respondents. The court stated that the franchisor’s principle argument of irreparable harm (i.e. damage to the integrity of the system) had no real force until the non-competition covenant was found to be both enforceable and applicable on the expiry of the agreement. Additionally, the court was of the view that any loss to the franchisor was quantifiable, noting that there was no suggestion in the case that the respondents would not be able satisfy a monetary judgment.

On the other hand, the consequences to the respondents of an injunction were immediate and probably irreversible, in that the injunction would result in a shut-down of the full-service bakery currently operated under the name “Bakery Nash.” The court also seemed persuaded by the fact there would be a loss of employment to employees.

Since the franchisor failed to show irreparable harm and the balance of convenience favoured the former franchisee, the injunction was refused.

Conclusions

A non-competition covenant will never be presumed to be enforceable. Therefore, franchisors should ensure that such covenants are (a) drafted as precisely as possible, (b) not overreaching, and (c) drafted to apply to the expiration of an agreement as well as to termination. Also, franchisors seeking to enforce a non-competition covenant should be in a position to submit evidence of irreparable harm; otherwise any alleged harm may be perceived as speculative. Finally, franchisors seeking to establish irreparable harm should also try to submit evidence that the respondent will be unable to satisfy any financial award.