A franchisee will be required to comply with certain provisions in the franchise agreement which restrict a former franchisees’ ability to operate, whether directly or indirectly, a similar or competing business, deal with former customers and poach ex-employees. Such restrictive covenants are vital in protecting the integrity of a brand’s network.
A franchisor must ensure that the restrictive covenants go no further than that which is absolutely necessary to protect a legitimate business interest and are reasonable in duration, scope and activity.
Recent case law has reiterated there are two key elements to bear in mind when considering the enforceability of restrictive covenants against competition. These are the protection of goodwill as a matter of common law and protection of know-how and assistance provided by the franchisor to its franchisee as a matter of Community Law under the Competition Act 1998.
The EU’s Vertical Agreements Block Exemption suggests that the restrictive covenants, to be enforceable, should not extend to the entire territory assigned to the franchisee, but should instead be restricted to physical space from which the contract goods or services were sold. However this is a complex area of law and must be considered in light of the ECJ decision in the Pronuptia case.
The restrictions should be drafted so that they also apply when the agreement comes to an end by the effluxion of time and not just on termination. In addition they should also extend to regulate post-term activity of key individuals (directors and major shareholders) who have had day to day conduct of the business.
In some instances, parties have continued to trade even though the franchise has come to an end. The question which often arises is which terms apply to the ‘holding over’ period, and in particular whether the post-termination restrictive covenants run from the date the agreement expired or when the franchisee in fact ceases to trade.
It cannot be assumed whether by analysis to landlord and tenant cases, by conduct or by implication that the parties are holding over on terms that include the post-termination non-compete provisions. Two High Court cases came to different conclusions on similar facts. However, a more recent case expressed a view (obiter) that the restrictive covenants applied into the holding over period and came into effect when the post termination trading ended.
Whilst a franchisee will not be free of restraint on termination, there are important hurdles for a franchisor to clear to ensure that its restrictive covenants are enforceable. This can no longer be taken for granted.
Gurmeet Jakhu is a Partner who specialises in franchise law. For more information please contact Gurmeet or another member of Nelsons’ Franchising team on 0800 024 1976 and they will be happy to assist.