Your pen is poised to sign the franchise agreement but stop! Have you checked the restraint of trade clauses in the franchise agreement? These generally seek to prevent the franchisee from either engaging in a competing business with, or soliciting customers or employees of, the franchise system. Such restraints are usually limited to a geographical area and remain for the lifetime of the agreement, and for a set time after its expiry.
However these restraints of trade are often unenforceable unless it can be shown that the clause is necessary to protect the franchisor’s legitimate business interests, after taking into account the competing interests of the franchisor, the franchisee’s right to earn an income and the general public’s interest in healthy competition in the market.
Interestingly, in assessing the franchisor’s business interests, the courts tend to look at the circumstances at the time the franchise agreement was entered into, rather than the circumstances existing when the restraint is sought to be enforced.
Traditionally franchisors have greater success when it comes to protecting the significant goodwill inherent in most franchise systems. Franchise agreements often contain restraints that are limited in scope, which the courts look upon favourably.
But recent court decisions have cast doubt over the general principles established in previous cases.
BB Australia Pty Ltd (Blockbuster) v Karioi Pty Ltd
This NSW Court of Appeal case involved an action by Blockbuster to enforce a restraint of trade clause in its franchise agreement against a former franchisee, Karioi.
In 1998, Karioi converted two of its privately-owned video stores to Blockbuster franchises, and signed franchise agreements (each for a term of 10 years). When the agreements expired, Karioi de-branded the stores and continued to operate a video rental business from the same locations.
The restraint clause in each franchise agreement purported to restrict Karioi from operating a video rental business within 30km of the store, for two years following the expiry or termination of the franchise agreement.
Each franchise agreement also included various clauses compelling the franchisee to destroy or return any of Blockbuster’s confidential information or intellectual property at the end of that agreement, which Karioi had done.
The court ruled that the restraint was unenforceable because other clauses in the franchise agreement afforded sufficient protection to Blockbuster and the protection of confidential information and intellectual property could not be used to justify a restraint clause as well.
The court also found that due to the magnitude of the brand and the significant number of Blockbuster stores, the goodwill in the brand was not specifically tied to any particular premises. Given that the franchisee had operated a video rental business from the premises prior to becoming a franchisee, the court found that Blockbuster’s goodwill in the site was not sufficient to substantiate the restraint.
This decision supports the position taken by the court in the earlier case of EzyDVD v Lahrs Investments, which was decided on very similar grounds.
Key consequences
The Blockbuster case means that franchisors and their legal advisors must take extra care when drafting restraint of trade clauses in their franchise agreement to ensure they are reasonably based.
The decision also indicates that larger franchise chains may have more difficulty than smaller chains in enforcing their restraints of trade, especially where the franchisee operated a similar business from the premises prior to joining the franchise system.
It is wise to check with an expert in franchising law to determine whether the restraint of trade clause in any franchise agreement you sign is enforceable. This may have an impact on what you decide to do with your business when it’s time to move on from your franchise.