The Sticky Issue Of Restrictive Covenants In Contracts

A recent case has highlighted the reluctance of the courts to intervene in “rewriting” these clauses to make them enforceable. This means it is even more important to review your contracts regularly.

Franchisors – you need to know that your restrictive covenants can be relied on, when needed.  

Franchisees – you need to know how restricted you really are if you want to get out of your franchise.

RC’s – the Law

The general rule is that a franchisor has a legitimate right to protect its interests in the territory where its franchisees operate. This means that when a franchise comes to an end for a reasonable period of time the franchisor can prevent the former franchisee from competing with the incoming franchisee and from poaching staff etc. The key word however is “reasonable”.

Your contract normally contains a severance clause. This allows a court to remove the offending part of a clause provided that it can be removed without needing to rewrite the contract. We lawyers call this the blue pencil test – literally, if you used a blue pencil to take out the offending part of the clause does the clause still work without needing to add any more words.

RC’s – The Lesson

In Francotyp-Postalia Ltd v Whitehead and others the Franchisor failed to win a case asking the court to alter the wording of its non-compete clause to make it enforceable. In this case to make the clause work the court would have had to not just “blue pencil” the offending part but also add in additional wording to prevent the proposed change affecting other clauses in the contract.

This meant the franchisor was unable to prevent his former franchisee from competing in the same area. (Although, the former franchisee was still prevented from poaching staff and customers because these clauses were enforceable.)

I’m a Franchisee – How does this affect me?

We are often asked to advise franchisees on the impact of restrictive covenants in their contracts if they decide to “cut out the middleman”.

Franchisees looking to derive more revenue from the business that they have built want to know: (a) how they can get out of their franchise contracts; and (b) what potential impact setting up competing business might have on them.

Whether your contract prevents you from competing or poaching staff and/or customers depends on how reasonable the restrictions are.

I’m a Franchisor – What steps can I take to avoid this happening to me?

• Futureproof your franchise by ensuring that your contracts contain appropriately drafted restrictive covenants and severance clauses.
• If you are thinking of terminating a franchise contract get a pre-termination review to check if you might have difficulty enforcing your restrictive covenants
• Get as much customer data and information from your franchisees. Take technological steps to garner data, and restrict their access to your proprietary information.
• Negotiate – if you know you won’t be able to enforce what you have in your contract use any leverage that you have to secure agreement to reductions.
• Keep the dialogue open and be co-operative. 

I’m a Franchisee – How can I use this to get around the RC’s in my contracts?

• Check the Legals – First get a fixed fee contract review to check the enforceability of your restrictive covenants.
• Tread carefully, you may be in breach of other provisions of your franchise contract if you compete even if the RC’s are void.
• Customers are loyal to people and not brands. Maintain good links with your customers.
• Do not discuss your plans with staff or customers until your franchise contract has come to an end.
• Maintain, if possible, good relations with your franchisor.
• Comply with the terms of your franchise contract.

Author: Fiona Boswell