When a franchise relationship comes to an end with a franchisee and the franchise agreement is terminated (amicably or otherwise), one common area of dispute is over the enforceability of the post-termination restrictions in the franchise agreement.
The rationale behind restrictive covenants
The purpose of a post-termination restrictive covenant in a franchise agreement is to protect the legitimate goodwill of the franchisor by preventing the know-how and assistance that the franchisor provided to the franchisee during the term of the franchise agreement from being used (after the termination of the franchise agreement) to aid the franchisor’s competitors (including the ex-franchisor).
However, one of the key requirements of a post-termination restrictive covenant is that, in order to be enforceable, the restraint on trade imposed by it must be no wider than is “reasonable” to protect the franchisor’s legitimate interest. Even if only part of a restrictive covenant is considered to be “unreasonable”, the whole restrictive covenant will be unenforceable unless the unreasonable part can be severed from the rest of the restrictive covenant.
Perhaps unsurprisingly, because the question of whether or not a restrictive covenant is no more than is “reasonable” to protect the franchisor’s interest is such a fact-specific issue, disputes over the enforceability of post-termination restrictive covenants in franchise agreements often end up in Court.
Dwyer (UK Franchising) Ltd v Fredbar Ltd
One such recent case that was considered by the High Court was Dwyer (UK Franchising) Ltd v Fredbar Ltd & another  EWHC 1218 (Ch). While the High Court found in favour of the franchisor in relation to several issues relating to the termination of the Franchise Agreement, the most interesting part of the judgment arguably relates to the dispute over the enforceability of the post-termination restrictive covenants.
In essence, the disputed restrictive covenants stated that the franchisee could not, for a period of one year following the termination of the Franchise Agreement:
- be involved in any business similar to, or competing against, “the Drain Doctor Business” in either:
- the franchise territory (which in this case was Cardiff), or,
- a five-mile radius of the territory.
The term “the Drain Doctor Business” was (perhaps surprisingly) not expressly defined anywhere in the Franchise Agreement, and so first of all, the High Court had to determine how that term should be interpreted. On this point, the High Court ruled that, in the context of the restrictive covenants, the term “the Drain Doctor Business” should be interpreted as meaning the business of “plumbing and drainage”.
This interpretation in turn meant that the restrictive covenant sought to prevent the ex-franchisee from having any involvement in any “plumbing and drainage” business in Cardiff, or within five miles of Cardiff, without exception. This would mean that the restrictive covenant prevented the ex-franchisee from even acting as a subcontractor or employee of any other “plumbing and drainage” business within the relevant area, even when any such sub-contracting and/or employment would have no effect on the franchisor’s protected goodwill. On that basis, the High Court ruled that the restrictive covenant was unreasonable in the circumstances, especially as it seriously increased the risk of that the ex-franchisee would become unemployed if the Franchise Agreement was terminated, thereby depriving him and his family of its primary source of income.
The High Court added that not only was the scope of the restrictive covenant unreasonable (as it went beyond what was “reasonable” to protect the franchisor’s interest), but the extension of the restrictive covenant to a five-mile radius beyond the franchise territory was also itself an unreasonable radius. Specifically, because the franchisee has never provided the franchise services outside of the franchise territory, there was no goodwill within that extended radius for the franchisor to reasonably protect.
As this was not a case where the Court considered it was possible to sever the unreasonable parts of the restrictive covenant from the reasonable parts, the High Court ruled that both restrictive covenants were entirely unenforceable.
Lessons to be learned
While this latest case, like most disputes over restrictive covenants, is very fact-specific, there are still a number of lessons that can be learned from the High Court judgment.
Firstly, because the restrictive covenant did not expressly define the precise nature of the work it was restricting (because the term “the Drain Doctor Business” was not defined anywhere), it left it open for the Court to rule that it covered any and all “plumbing and drainage” businesses. If the restrictive covenant had attempted to narrow the scope of the work it was restricting (to only what was “reasonable” to protect the franchisor’s interest) then it may have potentially been considered enforceable.
Similarly, if the restrictive covenant had not been drafted so widely that it prevented the ex-franchisee from acting as a subcontractor or employee in circumstances where it would have no effect on the franchisor’s protected goodwill, then the Court may have considered the restriction to be reasonable.
Finally, when considering the geographic scope of a restrictive covenant, the decision makes it clear that you should consider whether or not the franchisor actually has any goodwill to protect within any extended radius referred to, bearing in mind that restrictive covenants will only be enforceable when they are no wider than is “reasonable” to protect the franchisor’s legitimate goodwill.
As the judge commented in the Dwyer case: “These prohibitions do not strike a reasonable balance between the freedom to contract and the freedom of trade. They are far more extensive than was required to provide reasonable protection”. These principles will continue to determine any further cases that reach the Courts over the enforceability of any such restrictive covenants.
If you need advice in relation to the drafting of post-termination restrictive covenants in franchise agreements, or if you are involved in a dispute over the interpretation or enforcement of the same, our specialist franchise disputes team can assist you. For more information on this or any other issue relating to franchise disputes, please contact Michael Axe.
This article is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from taking any action as a result of the contents of this article.