In the recent High Court case of PSG Franchising v Lydia Darby, a year-long restrictive covenant in a franchise agreement to protect the franchisor's goodwill post-termination, was held to be valid and enforceable - despite being drafted in broad terms.
Interestingly, the Court imposed an injunction on the franchisees to give effect to the restrictive covenant thus protecting the franchisor's 'legitimate business interest' in its goodwill.
This is a remedy the Courts will not grant lightly.
What was the case about?
The franchisor looked to enforce post-termination restrictive covenants contained in a franchise agreement. The franchisor was a local property search business. Its franchisees used its system and know how to provide the property search information typically required by conveyancers and lenders within particular franchised territories.
The successful restrictive covenant included a prohibition on the franchisees from being 'directly or indirectly engaged concerned or interested in any capacity whatsoever. in any business which provides any services which compete with any of the services provided by the [franchisor] or any of its franchisees' within the defined territory (being the post code areas stated in the agreement).
Restrictive covenants are often rendered unenforceable due to being held to be too broad and hence 'unreasonable'.
Here, the High Court illustrated a willingness to adopt a construction favourable to the franchisor which limited the clause to the reasonable protection of a legitimate business interest, thereby making the clause valid and enforceable.
In particular, the restriction was held to be reasonable because it only prohibited the provision of competing services within a clearly defined territory, and as such protected the franchisor and a new franchisee from competition within that territory, but left the franchisee free to trade in competition outside the territory.
The High Court emphasised the need to apply 'commercial common sense'. It stressed that the protection of a legitimate business interest of the franchisor was to be no more extensive than reasonably necessary to achieve that end.
Lessons for franchisors
- Franchisors should ensure that their franchise agreements contain wording that prevents franchisees from competing with them in the relevant territory, both during the term of the franchise agreement and after it ends.
- Drafting has to be done with care to ensure there is neither a competition law issue (due to restraint of trade), nor that it can be deemed to be unreasonably extensive resulting in unenforceability. However, this case shows that applying business common sense in the applicable circumstances will assist in persuading a court that such a restriction is reasonable and should be upheld.
- Note that where such restrictions are absent from the franchise agreement, this can also result in a decreased value of the goodwill in question and make the territory of the former franchisee more difficult to sell.
- Consequently, when drafting a restrictive covenant it is necessary to be mindful that the courts will uphold only those clauses which achieve the reasonable protection of a franchisor's legitimate business interest. There is no guaranteed formula to achieve this, but business common sense should be deployed to assess what is reasonable in the circumstances in question.