Restraint of Trade clauses can be commonly found in not only franchise agreements, but in sale of business and employment agreements.
Such clauses are only valid and enforceable where the restraint is reasonable.
The courts generally take a stricter and less favorable view of restraints of trade in employer – employee contracts than those in vendor – purchaser contracts.
One of the reasons for doing so is that ‘by agreeing to a restraint on further employment, an employee may be, wholly or partially, giving up his or her ability to work after the present employment ceases.
On the other hand, when a business is sold, it may not have any value to the purchaser, if the vendor is not restrained from competing for at least a limited period.’
Purpose of the Restraint of Trade Clause
In franchise agreements, the purpose of the restraint of trade clause is to prevent a franchisee from competing with the franchisor, in the event that their franchise agreement ends.
As a general rule, such clauses are only enforceable if considered a reasonable means of protecting the franchisor’s goodwill at the time when the franchise agreement is made.
Reasonableness of the restraint is determined by considering the interests of the franchise parties: the restraint must afford no more than adequate protection to the franchisor, and must not be injurious to the public.
Franchise Agreement Restraint of Trade Case – BB Australia Pty Ltd v Karioi Pty Ltd
A recent decision of the QLD Court of Appeal in BB Australia Pty Ltd v Karioi Pty Ltd [2010] NSWCA 347; (2010) 278 ALR 105 illustrates how the court determines the reasonableness of a restraint of trade clause in a franchise agreement by considering whether the particular features of the franchise relationship are akin more to an employer – employee relationship or that of a vendor – purchaser.
Blockbuster and Karioi had entered into two franchise agreements on 2nd April 1998.
Under the agreements, Karioi was granted the right to conduct its existing video businesses at Noosaville and Nambour in Queensland as Blockbuster video stores.
Separate clauses in the agreement imposed restrictions on Karioi’s use of confidential information; the delivery up of confidential material and an option granted to Blockbuster to purchase assets (including leasehold interests) used in the franchise operations.
The franchise agreements expired in April 2008. Karioi, with Blockbuster’s consent, continued to operate the stores as Blockbuster franchises until 31 August 2008.
Blockbuster sought injunctions restraining Karioi from operating a video hire business within 30 km of the Noosaville and Nambour stores for a period of two years from 1 September 2008.
Blockbuster argued that the restraints were reasonable protection of Noosaville and Nambour video stores’ goodwill, which could be divided into three aspects:
- The stores’ patronage
- The stores’ location
- The other industrial property and confidential information including Blockbuster’s operating systems, marketing strategies and pricing structures.
However, the Court of Appeal rejected this argument. MacFarlan J (Giles JA and Sackville AJA agreeing) considered that Blockbuster did not own, nor was likely to acquire during the currency of the franchise agreement, any goodwill in the businesses at the two locations.
The Court of Appeal agreed in this regard with the first instance judgement of Price J, when he rejected that Blockbuster’s goodwill was an interest in the location of the stores, relying on the facts that the leasehold interests were Karioi’s assets, which Blockbuster had the option to purchase upon the expiration of the franchise agreement and which had not been exercised.
Further, the Court of Appeal did not consider that Blockbuster had an interest in the stores’ patronage.
Rather the court considered that any goodwill generated from the business arose from its location, or the brand under which it operated.
Benefits generated from the use of the Blockbuster brand were not considered to be of an enduring nature as the parties would not reasonably have expected Karioi to use any part of the Blockbuster Systems after cessation of the franchise agreement.
Given Blockbuster’s lack of interest in the stores’ goodwill the Court of Appeal thought the relationship between Blockbuster and Karioi was not analogous to vendor/purchaser cases.
The Appeal court then considered if the restraint of trade could be justified as reasonable by reference to factors considered in the employer/employee category of cases.
In such cases, where the employee will develop personal connections with customers such that the customers may follow the employee to a new business, it may be reasonable for the employer to impose a contractual restraint upon the employee operating such a new business.
However, such factors did not exist in the Blockbuster – Karioi franchise, the court, citing Blockbuster’s own evidence of the importance of location and brand, suggested an absence of such connections.
The Court of appeal determined therefore that the restraint of trade was unreasonable and dismissed the appeal.
The restraint of trade clause could not be enforced against Karioi.
The clause conferred greater protection to Blockbuster than could be justified, given that Blockbuster had the ability to separately protect its interest in the goodwill of the businesses by exercising the purchase option and that Blockbuster’s interest in any confidential information and industrial property were separately protected under the franchise agreement.
Insights on the franchise restraint of trade case outcome
Consider the unique circumstances of franchisor and franchisee
The decision reinforces the point that the reasonableness of each restraint of trade clause will depend upon the unique circumstances of franchisor and franchisee.
Courts recognise that franchisors have an interest in protecting the patronage developed by the franchise, which may be lost if the franchisee is permitted to compete without restriction.
As well, the franchisor also has an interest in preserving the confidentiality of information provided to the franchisee.
This legitimate interest in protecting the franchisor’s goodwill must, however, be balanced against the franchisee’s interest in protecting the goodwill of its business, including its customers.
Existence of adequate alternative contractual mechanisms
Thus, if there are adequate alternative contractual mechanisms within the franchise agreement, aside from the restraint of trade clause, which protect the interests of the franchisor’s goodwill or confidentiality of information, then the restraint of trade clause may be considered unreasonable.
The restraint of trade clause provides an unjustifiable level of protection to the franchisor, at the expense of the interests of the franchisee and the general public.
Tailoring the Restraint of Trade Clause
The importance of a properly drafted restraint of trade clause in preserving the goodwill of the franchisor’s business cannot be underestimated.
In light thereof, restraint of trade clauses should be tailored individually to each franchisor – franchisee relationship to avoid the risk of the clause being declared unenforceable.
The above post is as information only and not legal advice.
Author Bio:
Jenny Dickfos, B Bus (QIT), LLB (Hons) (QUT), LLM (QUT) is currently completing her PhD studies at University of Queensland. Her PhD thesis considers the adoption of enterprise liability as a safeguard for unsecured creditors contracting with corporate group members. Jenny lectures and tutors, at both an undergraduate and postgraduate level, in Business Law and Company Law courses at Griffith University. Her current research interests include the regulation of corporate groups and insolvency law. Prior to holding her current position as Lecturer in the Griffith Business School, Jenny has been employed in the Audit, Tax and Accounting sections, of a number of large and small accounting firms in Brisbane and on the Gold Coast. Jenny is a CPA (Certified Practising Accountant), member of the Tax Institute of Australia and member of the CLTA (Corporate Law Teachers Association).