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English Courts find franchisors may not always rely on standard restrictive covenants in franchising agreements

Posted on 13 September 2022

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The Court of Appeal recently dismissed an appeal from a High Court decision. It held that inequality of bargaining power is a significant factor in assessing reasonableness of a restraint of trade provision in franchising agreements.

Franchisors must be careful when drafting or enforcing post-termination non-compete provisions in franchising agreements, and ensure that any such restrictions do not go further than protecting their legitimate business interests. They must strike the right balance between protecting such interests and the franchisee's ability to earn a livelihood going forward. This case provides a stark reminder that there is no such thing as a "standard form" post-term restriction and such provisions in franchising agreements need to be drafted carefully, tailored to the specific circumstances of the case to ensure they are upheld by the courts, and not struck down as this could lead to the franchisor inadvertently losing any protection that such clauses might otherwise offer.

This case also highlights some of the factual considerations that may be relevant when contemplating enforcing a restrictive covenant, including:

  • equality of bargaining power;
  • how long and successfully has the franchisee been trading;
  • how substantial is the franchisor's goodwill that should be protected, and;
  • in case of a territorial restriction, does the franchisor have goodwill, within the restricted territory, that justifies the protection sought? 

Background

The claimant, Dwyer (UK) Franchising Limited (the "Franchisor"), is the UK franchisor of the Doctor Drain concept, which is claimed to be the country's largest full-service network of emergency plumbing and drainage.

In 2018, the claimant entered into a franchising agreement with Fredbar Limited (the "Franchisee"), which entitled the Franchisee the exclusive right to trade within nine specified postcode areas within the Cardiff  area (the "Territory") for a 10-year period, provided that for a period of one year post termination or expiry of the agreement, neither the Franchisee nor Mr Bartlett (who was the director and shareholder of the Franchisee and guarantor of its obligations under the franchising agreement) would be "engaged concerned or interested in a business similar to or competitive with" the Doctor Drain business either within (i) the Territory or (ii) a 5-mile radius from the Territory (together, the "Restrictive Covenants").

The Franchisor claimed that the Franchisee committed a repudiatory breach of the franchising agreement when it purported to terminate that agreement in July 2020 and sought damages as well as injunctive relief to restrain the Franchisee and Mr Bartlett from carrying on the competing business.

The High Court handed down judgment in May 2021 and found that the Restrictive Covenants were unenforceable as they did not strike a reasonable balance between the freedom to contract and the freedom to trade, and were far more extensive than required to provide reasonable protection to the Franchisor and accordingly dismissed the Franchisor's applications for injunctive relief.

The Franchisor appealed the decision on the grounds that:

  • In concluding that the Restrictive Covenants were unenforceable the Judge erred by considering irrelevant and impermissible factors; and
  • the Judge erred in concluding that any unreasonable part of the Restrictive Covenants could not be severed

Decision

The Court of Appeal held that in determining the reasonableness of restrictive covenants, the court will consider a number of factors including the factual and contractual background and the relative bargaining strength of the parties, which involves looking at the circumstances of franchisees. In order for a restrictive covenant to be held to be reasonable, the restraint must be no more than what is reasonably required by the party in whose favour it is imposed to protect his legitimate business interests.

Inequality of bargaining power was not only relevant but a significant factor in determining the reasonableness of a restrictive covenant, and where such inequality exists, the court will analyse the restrictive covenant critically and ensure it is only upheld if it is objectively reasonable between the parties in all the circumstances, and where inequality of bargaining power exists, a franchise agreement may be more akin to a contract of employment than to a contract for a sale of a business.

In this instance, there were a number of factors which demonstrated the inequality of bargaining power between the parties. The Franchisor was the largest emergency plumbing and drainage company in the country with over 30 franchises covering sixty territories, whereas Mr Bartlett was essentially "a man with a van" (which was also hired) who had invested all his savings in the franchising business and had no previous experience. Additionally, the facility agreement had to be accepted or rejected in its standard form without amendment.

Another aspect which the judge had in mind when considering inequality of bargaining power was the degree of risk which Mr Bartlett undertook, as he had invested practically all his savings in the arrangement and was at serious risk of losing his family home if the business were to fail.

The restriction was also held to be unreasonable as it failed to distinguish between the position if there was an early termination of the franchising agreement as opposed to the position had the franchise been running for the full 10-year period or a substantial part of it, where the goodwill to be protected is likely to have been worth substantially more. At the time of the Franchisee's repudiatory breach, the franchise had only been running for a period of 18 months (four of which were during the pandemic) and the earnings were limited and far less than the projections, which contributed to the 12-month restriction being held as unreasonable.

The court then considered the restrictive covenant regarding the five-mile radius buffer zone, which it followed was also held to be unreasonable and unenforceable since it extended to an unnecessary range and area where the Franchisor had not previously provided services and accordingly had no goodwill to protect.

The judge also emphasised that the restrictions are unenforceable on the facts of the case, but the 12-month restriction would not be unreasonable in every Dwyer franchise agreement and where the Franchisee is well-established, sophisticated and successful, or the Franchisor can show strong evidence for a need to protect its goodwill, a court may well conclude that the restriction is in fact reasonable.

On the second ground of appeal, the court looked at various suggested amendments to the restrictive clause to make it reasonable, for example, removing the restriction on doing trade within a 5-mile radius from the territory, but ultimately concluded that the unreasonableness could not be remedied by the application of blue pencil.

Accordingly, the Court of Appeal dismissed both grounds of appeal.

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