Ontario Court of Appeal Affirms Enforceability of Non-Competition Covenants in M&A Transactions

INTRODUCTION

The recent 2024 decision of the Ontario Court of Appeal (the “ONCA”), Dr. C. Sims Dentistry Professional Corporation v. Cooke has reinforced the principle that Ontario courts will generally not intervene to invalidate non-competition covenants in M&A transactions. Rather, the ONCA confirmed that in the M&A context, these covenants represent thoughtful negotiations between sophisticated parties, which create binding and enforceable obligations, except in extraordinary circumstances. 

SUMMARY OF CASE

Facts

Dr. Sims acquired Dr. Cooke’s dentistry practice for $1.1 million. The agreement of purchase and sale (the “Purchase Agreement”) included a non-competition clause (both as part of the Purchase Agreement and in the form of a stand-alone agreement) that, among other things, prevented Dr. Cooke from practicing dentistry within a 15 km radius of the acquired practice for a period of five years. Upon the completion of the transaction, Dr. Cooke was to maintain employment at the acquired practice for two years, or until either party terminated his employment with sufficient notice. Shortly after Dr. Sims exercised his right to terminate Dr. Cooke’s employment services, Dr. Cooke conveyed an intention to work at a dental practice located only 3.3 km from the acquired practice. Dr. Cooke took the position that the non-competition covenant was unenforceable.

Dr. Sims objected to the breach of the non-competition clause, arguing that the $1.1 million purchase price he paid for the acquired practice included goodwill – the value produced by the intangible assets, such as its brand name, logo, and clients. Such goodwill could be diminished, however, if existing patients could easily decide to follow Dr. Cooke to a new practice before beginning to trust Dr. Sims as their dentist.

Holdings

The trial judge upheld the non-competition clause, finding that it was reasonable based on the following grounds:

1. the Purchase Agreement was agreed to and negotiated by sophisticated commercial parties who had access to legal counsel;
   
2. the five-year duration was reasonable based on evidence of the length of time required for patients to build a loyal relationship with a new dentist; and 
   
3. the 15 km radius was appropriate compared to similar cases involving dental practices.

These conclusions were upheld on appeal. The ONCA noted that the trial judge was correct to state that the commercial nature of the transaction is a determining factor in enforcing non-competition covenants. Due to the value that the court places on freedom of contract, it would require exceptional circumstances to invalidate an agreement made between two equally informed parties. Whereas a non-competition agreement made in an employment context is more likely to attract the court's intervention, due to an inherent power imbalance between employers and employees, such power imbalance is not apparent in the commercial context of an M&A transaction.

With respect to goodwill, the ONCA held that the purpose of a restrictive covenant is to protect the goodwill being sold from a devaluation caused by the seller’s actions. Such clauses prevent sellers from acting in a manner that could devalue what was sold to the purchaser, thus ensuring the purchaser obtains the value for which it bargained. Ultimately, the ONCA affirmed the enforceability of non-competition covenants negotiated in the commercial setting, so long as they are reasonable.

TAKEAWAY FOR SELLERS IN M&A TRANSACTIONS

At the time of negotiation, a seller must recognize that a non-competition covenant is not merely an ancillary element of the transaction. Courts will continue to enforce these covenants in the M&A context. Sellers should therefore consider their long-term career consequences when negotiating agreements of purchase and sale. For example, sellers should consider:

1. their age;
2. their opportunity for other work, particularly in the context of professionals with a specialized and specific skillset; and
3. their opportunity/ability to retire.

The foregoing factors should particularly be considered when negotiating and assessing the purchase price for their business.

TAKEAWAY FOR PURCHASERS IN M&A TRANSACTIONS

To hold the seller to its non-competition covenant, a purchaser should take necessary precautions to ensure that the agreement is reasonable in the circumstances. While the ONCA affirmed that these covenants are enforceable in an M&A setting, the court nonetheless constrained this enforceability with the concept of “reasonability.” Therefore, purchasers should consider industry standards for the scope and duration of a non-competition covenant. This can provide a higher level of confidence as to the enforceability and reliability of such covenants in the future.

Written by Charlie Kim, with the assistance of Matthew McGuigan, and Lexy Mogil.