RESTRAIN YOURSELF

What franchise buyers need to know about restraint-of-trade clauses in (and after leaving) a franchise.

Restraint-of-trade clauses have an impact on your franchise operation.

Buying a franchise is a big decision, and reviewing a 50- to 100-page franchise agreement can be a daunting task. Consequently, franchisees often overlook how a restraint-of-trade clause will impact their business both during and after the franchise term. The way these clauses work in practice could impact your commercial plans. A restraint-of-trade clause in a franchise agreement permits the franchisor to stop you, as the franchisee, from either:

1. competing with the franchisor in the same

industry, called a non-compete clause; or 2. poaching the franchisor’s employees, clients, prospective clients or other franchisees (or their employees, clients or prospective clients), called a non-solicitation clause.

A franchisor can enforce a restraint of

trade against you only if they can show that the restraint is reasonably necessary to protect their legitimate business interests. This takes into consideration factors such as industry, location and time. The restraint clause will generally apply to a specific geographic area (within a 20km radius of your store, for example) and period of time (such as 12 months after the termination or expiry of the agreement).

Courts have generally recognised that franchisors can enforce some kind of restraint because they have a legitimate business interest to protect: their client base. This is because, in creating a franchise system, a franchisor has developed goodwill.

COURT OPTIONS

Often, the restraint will be drafted as a cascading clause, with several alternatives in terms of time and geography. Do not assume the court will enforce the broadest restraint. The purpose of a cascading clause is to provide the court with options. For example, a 50km restraint for a cafe franchise in a CBD location is unlikely to be reasonably necessary to protect the franchisor’s interests. However, a 2km restraint might be.

Restraints can also apply during the term of the franchise agreement. The court is likely to enforce such restraints because you are receiving the benefit of the franchise’s image and systems. Accordingly, the franchisor has a legitimate business interest.

You should consider whether these restraints will interfere with your commercial plans, especially if you already have, or intend to open, another business, or even another franchise at the same time. If this is the case, you should negotiate with the franchisor to include a special condition that allows you to be involved in the other business, even though it may compete. It is extremely risky to not disclose the other business and hope the franchisor will be okay with the arrangement if they find out.

It is also common practice for a franchise agreement to make restraints binding on guarantors, directors or shareholders of your company. You should revisit the business structure through which you plan to enter into the franchise agreement to ensure you are clear who will be bound by the restraints.

YOU ARE RESPONSIBLE

It is also common for the franchisor to require you to issue employment agreements that replicate the restraints contained in your franchise agreement. Ultimately, you are responsible if your employees breach the restraints.

It is important you understand that your franchisor can enforce restraint clauses against you even after you exit the franchise. Of course, whether the franchisor is successful will depend on how reasonable the restraint is and if the franchisor has a legitimate business interest. Depending on your industry, restraints can last for up to two years (sometimes even longer) after your franchise agreement ends. They can also cover a large geographical area.

For example, an e-commerce franchisor could seek to impose an Australia-wide restraint because they want to sell their goods (and therefore protect their business interests) nationally.

This means that before you sign your franchise agreement, you should think about your future commercial plans and what life might look like after you exit the franchise system. If you aren’t looking to invest long term in the franchise, you could try to negotiate less stringent restraints for when you exit or terminate the agreement.

It is possible to enter into a post-exit settlement agreement with the franchisor to remove, or limit, the effect of the restraints, but it is always better to negotiate suitable terms from the outset.

You should also know that if you sell the business, the buyer will be interested in imposing restraints on you, independent of any restraints the franchisor imposes.

INJUNCTION POSSIBLE

If the court finds that a restraint is reasonable, and therefore enforceable, and you have breached that restraint, it is possible for it to order an injunction against you. An injunction will stop you from continuing to do something such as running a competing business) and can be granted on an urgent temporary (“interlocutory”) basis. This is much more likely to happen if you, for example, try to solicit clients as soon as you leave the franchise.

The court can also order that you pay damages to the franchisor. The court will calculate these damages based on the lost income or profit the franchisor would otherwise have likely received if you had not breached the restraint.

Remember, as a franchise buyer you should be sure to carefully consider the effect of any restraint of trade clauses before signing a franchise agreement. You should assess the extent of the restraints within the context of your current and future commercial plans and, if necessary, negotiate less-stringent restraints to accommodate those plans. Approaching your review of the franchise agreement with your commercial goals front of mind will ensure the document you sign is one you thoroughly understand and feel comfortable with.

Jonathan Muncey is a franchise lawyer at LegalVision specialising in advising both franchisors and franchisees on transactions, contracts, and a range of related legal issues.

It is possible to enter into a post-exit settlement agreement with the franchisor to remove, or limit, the effect of the restraints, but it is

always better to negotiate suitable terms from the outset.