Franchising has long been an intrinsic feature of the retail sector and the mechanisms that franchisors put in place to protect their businesses have been around for almost as long. One such protection is the restrictive covenant, used to prevent franchisees from cashing in on the franchise model without recourse to the franchisor.
This bulletin covers two recent cases, serving as a useful reminder to all retailers (not just franchisees) that business protection can play just as important a role as business development.
The issues
The question of restrictive covenants in franchise agreements and their validity was examined in the case of Pirtek (UK) Limited v Joinplace Limited (2010) and some useful clarification was given on a couple of points.
A franchisee acted in breach of a non-compete clause in the franchise agreement by setting up a new company in competition with the franchise business.
The franchisor obtained an injunction to prevent the business competing, and brought a claim for breach of the franchise agreement. The franchisee counter-claimed arguing that the restriction was not valid because the franchisor's know-how was no more than general business acumen, which the franchisee possessed in his own right as an experienced businessman.
The franchisee also argued that he had not breached the restrictive covenant because he was not involved in the new business and was only supporting his partner who was running the new business.
The decision
The Court confirmed that a franchisor must be able to communicate his know-how to franchisees and offer them assistance in putting a system in place, without running the risk that his know-how and assistance will aid his competitors.
It was also confirmed that a period of restraint limited to one year, and limited to the franchise territory, was no more than was reasonably necessary to protect the franchisor's goodwill by breaking the association in customers' minds of the franchisor's goodwill with the franchisee himself. Accordingly, the restrictive covenant was accepted as necessary for the protection of goodwill.
The Court further found that the new business's methods were similar to the franchisor's and was both planned to, and did, compete with the franchisor's business. The franchisee had therefore breached the restrictive covenant.
In another very recent case on a similar topic, Agency Express v Martin, heard earlier this month, the court found that, in the case of a dispute regarding the validity and effect of a restrictive covenant in a franchise agreement, the franchisor should be allowed an interim injunction to prevent the franchisee from acting in breach of the restrictive covenant.
What does all this mean for retailers?
These cases support franchisors' ability to rely on post-termination restrictive covenants and give comfort to those who have recently been concerned that the courts would not enforce restrictions lasting for more than six months. The Court did, however, state that the validity and strength of a restrictive covenant was something to be assessed on a case by case basis. It is therefore vital to consider the terms of any restrictive covenants on the basis of the type of new business to be carried on by the franchisee.
Take action!
Ensure that any restrictive covenants in your agreements, franchising or otherwise, are neither too long nor too wide, otherwise they may fail by virtue of unreasonableness and your business will not be protected from competition as you may have thought.
The wider issue for retailers is of course about protecting their business model and unreasonable competition. Usually it is not until retailers have been 'stung' that they become fully aware of the chinks in their business protection, but those retailers that spend time identifying where those chinks might be very often find that it turns out to be time valuably spent.
The contents of this brochure are intended as guidelines for clients and other readers. It is not a substitute for considered advice on specific issues. Consequently, we cannot accept any responsibility for this information or for any errors or omissions.
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