Restraint of trade clauses in Franchise Agreements – when are they enforceable?

Standard restrictions on restraint of trade clauses

Courts are reluctant to enforce restraint of trade clauses, and will only enforce these clauses where they protect a legitimate business interest.

Where a restraint of trade clause is a protection of a legitimate interest, it will need to be shown that the restrain provides no more than reasonable protection.

Courts determine the reasonableness of a restraint of trade clause by looking at:

1. the scope of the activity restrained;
2. the geographical area covered; and
3. the duration of the restraint.

New South Wales is the only state to have specific legislation which relates to restraint of trade clauses. This legislation reflects the common law position that restraint of trade clauses will be valid except to the extent that they are against public policy.

Restraint of trade clauses

A restraint of trade clause, in a franchising context, allows franchisors to protect their legitimate business interests by restricting a franchisee’s freedom to undertake certain activities during or after the end of the franchise agreement.

Most commonly, these clauses will restrict the franchisee:

1. from soliciting employees from other franchisees or the franchisor;
2. disclosing any confidential information of the franchisor or franchise system; or
3. from conducting a similar business in a certain area, for a certain period after the end of the franchise agreement.

Restraint of trade clauses in Franchise Agreements

Under the Franchising Code of Conduct, where a franchisor does not extend a franchise agreement for a further term  at the request of the franchisee, a restraint of trade clause will not be enforceable where the franchisee is not able to claim compensation for goodwill. For a restraint of trade clause to be enforceable, the franchise agreement must allow for the franchisee to claim compensation for goodwill on the basis of the franchisor not extending the agreement.

This enforceability will not apply where the franchisee:

1. does not give written notice to the franchisor seeking to extend the agreement on substantially the same terms as those contained in the current agreement or that apply to other franchisees;
2. is in serious breach of the agreement, or any related agreement; or
3. infringes on the intellectual property of the franchisor during the agreement.

For example, where a franchise agreement does not provide for goodwill compensation, but the franchisee has infringed on the intellectual property of the franchisor during the agreement, the restraint of trade clause will be enforceable, subject to more general restrictions on restraint of trade clauses referred to above.

Goodwill compensation

Goodwill compensation must be included in the franchise agreement and must be ‘genuine compensation’ rather than a nominal amount. This provokes the question of what constitutes ‘genuine compensation’, as this is not something that is defined under the Code.

A clause providing for goodwill compensation should outline that upon the ending of the franchise agreement, the parties will negotiate in good faith a compensation amount. Where an agreement is reached, franchisees should sign an acknowledgement that they consider this a genuine compensation.

Conclusion

Franchisors should firstly consider whether they wish to restrict franchisees from operating a similar business after the expiration of the franchise agreement. Franchisors that wish to do so should ensure that the agreement provides for franchisee compensation for goodwill where the agreement is not renewed in order for restraint clauses to be enforceable.

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This article in no way constitutes legal advice. It is general in nature and is the opinion of the author only. You should seek legal advice tailored to your individual circumstances before acting on anything related to this article.

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