RESTRICTIVE COVENANTS IN FRANCHISE AGREEMENTS
A franchisee is in a good position to compete with a franchisor at the end of a franchise agreement. Franchisors should think seriously about securing a promise from the franchisee not to compete at the end of the franchise agreement. Franchisors should take care when drafting a restrictive covenant as if it is unreasonable, the restriction will not be enforceable.
During the term of a franchise, a franchisee will likely to have built up significant goodwill in the franchise territory through the use of the franchisor’s name, branding, confidential information and other intellectual property rights. The goodwill is therefore a valuable asset However, the franchisor’s interest in that goodwill is vulnerable to competition from a former franchisee. The franchisor’s knowledge of the franchise market and other skills developed through operating the franchise puts the franchisee in a good position to compete with the franchisor or any replacement franchisee at the end of the franchise agreement. This could damage the goodwill in the franchisor’s franchise business. A franchisor may also have much greater difficulty in attracting a new franchisee to the territory if a known former franchisee is operating a competing business in the territory. For this reason, franchisors should think seriously about imposing restrictive covenants on their franchisees. These may include a restriction on competing for a period of time after the franchise agreement ends. This protects the goodwill in the franchise territory, giving the franchisor breathing space to find a replacement franchisee who will operate the franchise in that territory and exploit the goodwill that the former franchisee has built up. If the covenant in the franchise agreement which restricts the franchisee from operating a competing business is valid then the franchisor may be able to restrain a breach of the covenant by injunction. The franchisor may also be able to claim damages for loss suffered as a result of the breach. What are the risks if the covenant is not drafted carefully? A restrictive covenant must be drafted carefully otherwise it may be unenforceable. Non competition clauses can be difficult to enforce. The English courts consider that such restrictions are not in the public interest so that a restrictive covenant will not be enforced unless the protection sought is reasonable. To be reasonable it must be in the interests of the parties to the contract and the public. In the case of a franchise business, goodwill is a legitimate business interest which can be protected.
Dorothy Agnew, Senior Solicitor Direct dial: +44 (0)23 8071 8078 Email: dorothy.agnew@mooreblatch.com
When assessing the reasonableness of a restrictive covenant, English courts tend to treat franchise agreements as akin to a business sale/acquisition situation and less like an employment contract which means that franchisors are more likely to obtain protection from competition. When drafting a restrictive covenant consideration should be given to factors such as the territory covered by the restriction and the duration of the restriction. These should be no greater than is reasonably necessary to protect the franchisor’s goodwill that has been built up in the territory. If a non-compete clause in a franchise agreement is drafted so widely as to be unreasonable the court will refuse to enforce the whole covenant unless the offending part can be severed. Franchise agreements that have a restrictive impact on trade may also have an anti-competitive affect and are therefore potentially subject to UK and European competition laws. For further information please see our Information Guide on competition laws. What you should you do? If you are a franchisor, do you impose restrictive covenants on your franchisees? If not, you may wish to consider adding such a covenant to your franchise agreements. If you do, you should keep the restrictive covenants in your franchise agreements under review. If you are a franchisee you should make sure that you understand the nature and effect of any restrictive covenants. You should consider negotiating changes to any restrictions on trade that you do not wish to accept. How can Moore Blatch help you? For franchisors, we can draft your franchise agreement or conduct a review of your existing standard franchise agreement. If you are a franchisee we can review and advise you on a franchise agreement before you sign it. Please contact us for further information about how we can help you.
The information contained in this update is correct as at May 2009. Moore Blatch is the trading name of Moore Blatch LLP, which is a limited liability partnership registered in England and Wales, registration number OC335180. The registered office is 11 The Avenue, Southampton SO17 1XF. The firm is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are members of the Law Society. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide. Regulated by the Solicitors Regulation Authority.