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New Case: Are Non-Compete Clauses Enforceable in Dental Practice Sales?

By May 17, 2024May 23rd, 2024Selling A Practice

Imagine investing years into building a successful dental practice only to face legal battles over non-compete clauses. A recent Ontario Court of Appeals case sheds light on such a scenario and offers valuable lessons for dentists.

Understanding Non-Compete Clauses

Before we discuss the case, let’s review non-compete clauses. A non-compete clause typically prevents a dentist from establishing or working in another dental practice within a set geographic area and time frame. These clauses can restrict the dentist from owning (even partially or indirectly), associating with, or working at another practice. The specific limitations differ in each case.

These clauses appear in various contracts, including purchase and sale agreements, associate agreements, shareholder agreements and partnership agreements.  But are they enforceable in an associate agreement?

At present, in Ontario, non-compete clauses are only enforceable in associate agreements in exceptional circumstances; otherwise, judges are reluctant to enforce them. However, that changes if the associate agreement forms part of a purchase and sale transaction. This means that if a selling dentist has agreed to stay on as an associate for a period of time to help with the transition as part of the sale agreement, a non-compete clause could be upheld.

The Case Background

In July 2017, Dr. Kevin Cooke sold his Hamilton dental practice to Dr. Christopher Sims for $1.1 million. As part of the deal, Dr. Cooke agreed to a 5-year non-compete clause. This clause held that Dr. Cooke would not directly or indirectly engage in the practice of dentistry or permit his name to be used in such a practice for five years following his association with Dr. Sims’ practice and within a 15 km radius of that same practice. This clause became the center of a legal dispute when Dr. Cooke started working at a nearby practice less than three years later.

The purchase agreement included a clause preventing Dr. Cooke from practicing within 15 km of his former practice for five years. However, Dr. Cooke began working at a clinic just outside the 15 km radius, leading Dr. Sims.

Dr. Cooke started working at a practice only 3.3 km away, and Dr. Sims sued Dr. Cooke, claiming a breach of the non-compete agreement. Dr. Cooke took the position that the non-compete clause he had signed was unenforceable.

At trial, the judge agreed with Dr. Sims that the non-compete covenant was valid and enforceable. Dr. Cooke appealed the case to the Ontario Court of Appeal, claiming that the trial judge had made a reversible mistake in finding the non-compete to be reasonable.

The Issues

The appeal considered the following key issues:

  • Whether the trial judge improperly cited law on the presumptive validity of a non-compete (i.e., which party bears the initial burden of evidence);
  • Whether the trial judge erred in upholding the duration and timeframe imposed by the non-compete (5 years) and
  • Whether the trial judge erred in upholding the geographic radius of the non-compete (15km from the sold practice).

The Decision

Dr. Cooke lost the trial but appealed one issue to the Court of Appeal – namely, the enforceability of the non-compete clause.

The Court of Appeal rejected these arguments, found in favour of Dr. Sims, dismissed the appeal and ordered Dr. Cooke to pay $30k to Dr. Sims. Here’s how the Court of Appeal got there.

The Burden of Proof

Dr. Cooke tried to argue that the non-compete clause should be treated as illegal unless Dr. Sims (the party trying to enforce it) can prove otherwise. The trial judge had adopted the approach that “in a commercial context, the restrictive covenant is deemed to be lawful unless it can be shown to be unreasonable“.

Courts have said that the reasonableness of restrictive covenants (like non-competes) will be scrutinized more in the context of employment. However, the non-compete here existed in the context of a negotiated purchase and sale of a business transaction. Because the parties in this context are more balanced as equal bargaining parties (rather than the power imbalance between an employer and an employee), Ontario courts have been more willing to enforce restrictive covenants, especially when there are sums of money that exchange hands between the parties, the clauses are reasonable in their scope and limitation, and there’s a legitimate proprietary interest that needs protecting.

The Court of Appeal considered a multitude of factors in concluding that it was reasonable for the trial judge to conclude that the non-compete was presumptively legal. One such factor was that the non-compete was agreed upon in the original offer by all parties and in the share purchase and associate agreements that followed.

The Duration

Dr. Cook argued that the 5-year duration of the non-compete was too long. Although the trial judge decided that the five-year non-compete clause was deemed necessary to protect Dr. Sims’ investment while getting to know the dental practice’s patients, Dr. Cooke’s appeal argued that the penalty of $750 for every breach of a non-solicit of a patient (i.e. a patient who leaves and follows Dr. Cooke) included in the non-compete clause was sufficient to protect Dr. Sims’ proprietary interest.

But the Court of Appeal referred back to the context of the non-compete. There was a sale of a business, including goodwill, which encompasses not just the existing patient base but also the ability to attract new patients from within the area served by the business. Allowing Dr. Cooke to work as a dentist within the restricted area and timeline of the non-compete would trade on the goodwill of Dr. Sims’ business. Hence, the court was not convinced that the trial judge had made a mistake regarding the reasonableness of the duration of the non-compete clause.

The trial judge accepted Dr. Sims’ argument that five years reflects the reality that it takes patients a number of visits to build a trusting relationship with their dentist.

The Geographic Radius

Dr. Cooke argued that the 15 km radius was too large to be enforceable because it covered an area larger than necessary. As a general rule, the territory to which a reasonable restrictive covenant applies should be limited to that in which the business being sold carries on its trade or activities as of the transaction date.

Dr. Cooke said that 90% of the patients came from the Greater Hamilton Area, Dundas and Ancaster (per the appraisal), but the 15 km went over and above by touching upon Burlington, Aldershot and Caledonia. But the Court of Appeal disagreed.

  • First, it found that radii’ are commonly used in non-compete clauses to identify how far a customer may be willing to travel to access services.
  • Second, the trial judge found other cases involving a 15 km radius, including one signed by Dr. Cooke when he worked in Simcoe; the trial judge found that patients were coming in from Stoney Creek and Ancaster, and thus the 15 km was reasonable.
  • Third, the valuation itself – which attributed $741k of the value of the practice to Goodwill – made reference to Dr. Cooke associating after the sale to help protect the transition of the Goodwill over to the patients.  The valuation assumed there would be a restriction in place for the vendor not to compete within a reasonable radius of the practice “for a period of time of no less than five years”.  So the valuation itself contemplated a five-year restrictive covenant over a “reasonable radius”.

Bottom Line

Restrictive covenants, including non-compete clauses, are typical in the purchase and sale of a business. But before you sign anything, keep in mind the lessons from this case:

  • Understand Enforceability: As seen in this case, context matters. Non-compete clauses are generally more enforceable in business transactions than employment agreements. Even then, striking a balance between protecting business interests and ensuring the clause is not overly restrictive is also key to enforceability.
  • Tailored Clauses: Each non-compete agreement should be tailored to the specific circumstances of the sale, considering factors like the nature of the practice, geographic location, and duration. Working with legal professionals experienced in dental practice sales will result in robust non-compete clauses that protect your business interests while being enforceable.

If you’ve already signed a non-compete agreement, contact our expert team at DMC for personalized advice on your situation. And if you’re considering selling your dental practice, make sure you have the right team in place to help you before signing anything. A lawyer experienced in dental practice transactions can protect you against any potential issues with a solid purchase and sale agreement. With DMC on your side, you’ll have lawyers who are dental industry insiders committed to protecting your interests. Email or call us today for a free consultation!

The Content of this post is provided for informational purposes only. It is not intended to be legal, financial, tax, or other professional advice of any kind. You are advised to contact DMC (or other counsel) to seek specific legal advice concerning your individual situation.

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