franchisee's post-termination restrictive covenants
upheld
...Pirtek (UK) Limited v Joinplace Limited and Others
This was a case focusing on a post-termination non-compete
clause which prohibited the franchisee from competing within a
specific area for one year post-termination of the agreement.
The franchisee acted in breach of this, by setting up a new company
with his live-in partner as director, and carrying on a competing
business.
The franchisor obtained an injunction which was maintained until
trial, and brought a claim for breach of the franchise agreement
and conspiracy. By the time the trial took place, more
than one year had elapsed since termination of the agreement
and so the franchisor was not pursuing any active claim against any
of the defendants, on the basis that it had been sufficiently
protected from loss by the injunction. However, the defendants
counterclaimed for the losses caused to them by the injunction and
malicious prosecution.
the issues
The franchisee argued that:
- the restriction was not valid because he claimed that the
franchisor’s know-how was no more than general business techniques,
and not specific to the franchisor’s way of business, which he, as
an experienced businessman, was familiar with anyway
- the franchisee had not breached the restrictive covenant
because he was not sufficiently involved in the new business to be
regarded as being in breach of the restrictive covenant, as it was
not the franchisee's business and his partner was running it.
Addressing the validity of the restrictive covenant, the Court
considered it in light of s.2 Competition Act 1998 (which prohibits
agreements which affect trade within the UK and have as their
object the restriction of competition within the UK, unless the
agreement falls within the s.9 exemption) and common law (which
focuses on the protection of goodwill and will only permit the
enforcement of restrictive covenants of this nature if
essential to protect the goodwill of the beneficiary).
In finding the restrictive covenant entirely outside the purview
of s.2 Competition Act, the court followed the decision in
Pronuptia, which held that a franchisor must be able to
communicate his know-how to franchisees and offer them assistance
in putting his methods into effect, without running the risk that
his know-how and assistance will aid his competitors, even
indirectly. Clauses essential to prevent this risk did not
constitute restrictions of competition for the purposes of s.2.
Such clauses could include a prohibition on the franchisee opening
a competing business in the duration of the franchise, or for a
reasonable period post-termination, in an area where he could be in
competition with one of the members of the franchise
network.
In this case, the franchisees and their staff had been provided
with extensive training and technical assistance, and business
management assistance in the form of an expensive IT system and the
franchisor's Operating Manual, which described how to run a
business in a way that would be attractive to customers, which
constituted the necessary know-how and assistance protected by the
restrictive covenant.
At common law, the franchisor's goodwill had become associated
in the minds of the franchisee's customers with the franchisee
himself. A period of restraint limited to one year, and
limited to the franchise territory, was no more than was reasonably
necessary to protect the franchisor's goodwill and accordingly, the
restrictive covenant was well within the type of restriction
accepted as necessary for the protection of goodwill.
Turning to the issue of the franchisee's involvement with the
competing business, the Court found that his role was essential to
the running of the business, as his partner had no know-how. It was
irrelevant that the new business did not have exactly the same
distribution method as the franchisor's business; it was similar,
and was both planned to, and did, compete with the business of the
franchisor. Accordingly, the franchisee had breached the
restrictive covenant.
As the Court found that the injunction had been properly sought
and granted, the counterclaim for losses attributable to the
injunction, and damages for malicious prosecution, failed.
conclusions
This case supports franchisors' ability to rely on
post-termination restrictive covenants and gives comfort to those
who have recently been concerned that the courts would not enforce
restrictions lasting for more than six months. The Court did,
however, sound a note of caution, observing that whether or
not a restrictive covenant was essential to prevent the risk that
know-how and assistance provided by the franchisor,would, after
termination, be used to aid the franchisor's competitors, was a
question to be assessed on a case-specific basis. It is therefore
important to consider the terms of any restrictive covenants on the
basis of the type of business to be carried on by the franchisee.
Restrictions of this nature are more likely to be effective against
franchisees requiring a greater degree of technical know-how and
assistance from the franchisor.
Likewise, at common law any clauses restricting the ability of
the franchisee to compete post-termination should be
carefully drafted to ensure they pass the test of what is
"reasonable". In Pirtek, a one year period coupled with an
geographic restraint limited to the franchise territory was
reasonable, but UK-wide restriction would not be.
