Post termination restrictive covenants ruling – does this mean you have to amend your franchise agreement?
1 Aug 2022 |
6 minute read
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The Court of Appeal has ruled on the enforceability of post-termination restrictive covenants in a 10-year franchise agreement in Dwyer (UK Franchising) Ltd v Fredbar Ltd & Anor (Rev1) [2022] EWCA Civ 889 (30 June 2022). It has upheld the decision of the High Court that certain restrictive covenants were unenforceable, due mainly to the circumstances under which they were agreed and the length of time and territory in question.
This is a noteworthy decision for franchisors and franchisees alike. Although some in the industry may consider the decision to mean the end of restrictive covenants, it is significant that the court stated that the decisions on enforceability were to be made on a case-by-case basis. Had the facts been different, it is likely that the decision would have differed as well.
Franchisors have been on tenterhooks awaiting this decision because the relevant restrictive covenant related to the prohibition of a former franchisee from operating a similar business within the territory after the termination of the franchise agreement. The decision highlights the important factors that led to the Court of Appeal finding that the particular clauses of the franchise agreement were unenforceable and may cause some franchisors to reconsider their approach to recruitment, the drafting of their agreements, or both.
It is well accepted that restrictive covenants (also known as restraint of trade clauses) are contrary to public policy and as a rule are considered unenforceable. As a result, the burden is on the party seeking to enforce them to show they are protecting a legitimate interest and that the restriction extends no further than is reasonably necessary to achieve that purpose.
Dwyer (UK Franchising) Ltd ("Dwyer") is a substantial company with more than thirty "Drain Doctor" franchises covering over sixty territories. It describes itself as the UK's largest full-service emergency plumbing and drainage company operating in commercial and domestic sectors, and its ultimate parent in Waco (Texas) is described by Dwyer as the world's largest home service franchise business.
Fredbar Ltd ("Fredbar") was a franchisee of Dwyer from around September 2018 until the summer of 2020. Fredbar was operated solely by Mr Bartlett and he set up the company for the purpose of joining the franchise.
The Court of Appeal was asked:
The relevant restrictive covenants in this case were set out in clause 18.2.1 of the franchise agreement and were as follows:
"18.2.1 Following termination or expiration of this Agreement, the Franchisee will not for a period of one (1) year thereafter directly or indirectly:
18.2.1.1 be engaged concerned or interested in a business similar to or competitive with the Drain Doctor Business within the Exclusive Marketing Territory (save for a financial interest which does not allow the Franchisee to influence the economic conduct of such a business).
18.2.1.2 be engaged concerned or interested in a business similar to or competitive with the Drain Doctor Business which operates within a radius of five (5) miles from the Exclusive Marketing Territory."
So, on the face of it, the clause itself was relatively narrow but lasted twelve (12) months.
The Court noted that a restraint of trade covenant is enforceable if the covenantee has something which is entitled to be protected and the covenant gives no more than reasonable protection for that. The issue was to be determined at the time the agreement was entered into, taking account of its expected duration.
The Court considered several factors in assessing reasonableness including the factual and contractual background and the relative bargaining strength of the parties, which necessarily involves looking at the circumstances of franchisees like Fredbar and determining if there is such a concomitant interest.
Here, the Court of Appeal held that the inequality of bargaining power between the parties was not only relevant, but a significant factor in determining reasonableness. It was also significant that Mr Bartlett had no previous experience in plumbing and drainage work. There was no discussion or negotiation of the restrictive covenants and Mr Bartlett did not take legal advice.
Such circumstances may be quite common with franchises, some of which are marketed on the basis of 'no prior experience' being required in view of the quality of the licensed system.
The other circumstances in this case were that:
As a result, the Court of Appeal held that the restrictive covenants were unreasonable and therefore unenforceable because:
The second restriction was found to be unreasonable because there was no protectable goodwill in the extended area outside of the territory as Fredbar had not provided services there.
So, overall, the clause was found to be unreasonable and parts of it could not be severed. Therefore, the clause was unenforceable.
The Court of Appeal did say that there cannot be some general rule that a twelve (12)month restriction in franchise agreements is reasonable. But that does not mean that a twelve (12)month restriction is unreasonable in every circumstance.
Following this decision, there are a number of issues which franchisors should consider to ensure that the restrictive covenants are more likely to be enforceable:
His decision is a good reminder from the Court of Appeal, that certain clauses may not be enforceable and it should prompt franchisors to review their franchise agreements and ensure that there is a legitimate reason behind each clause (particularly when it is a restraint of trade). If the clause cannot be defended as reasonable and legitimate, the court is more likely to find that it is unenforceable
John Shaw, Associate, Intellectual Property
To see the full Full judgment, please click here.
If you need legal advice around this subject, please contact our franchise lawyers or our expert IP law team.
If you would like us to review your post termination restrictions or any other terms of a franchise agreement, please do contact John Shaw.
