Restraint of trade clauses are common in franchise agreements and are designed to protect the franchisor's legitimate business interests.
It is important for franchisees to carefully review and understand the restraint of trade clauses in their franchise agreements to ensure compliance and avoid potential legal issues.
Understanding Restraint of Trade Clauses in Franching
Restraint of trade clauses typically restrict franchisees from engaging in certain activities, such as competing with the franchisor or soliciting customers or employees, both during the term of the franchise agreement and for a period after the franchise agreement ends.
However, as we set out in our previous article Restraint of Trade Clauses in Franchise Agreements, a restraint of trade clause will not necessarily apply or be enforceable.
In order to be enforceable, a restraint of trade clause should do no more than what is reasonably necessary to protect the legitimate business interests of the person who is trying to enforce the restraint. Consequently, in order to assess whether a restraint of trade is reasonable, Courts will generally look at the activity that is being restrained, the area in which the activity is being restrained and the time period for which the activity is being restrained.
Franchisees should seek legal advice if they have any questions or concerns about the scope and enforceability of these clauses.
Restraint of Trade Clauses in Franchising - Recent Legal developments
There have been a number of recent legal developments relating to restraint of trade clauses in franchise agreements.
ACCC Guide - Unfair Contract Terms in Franchise Agreements
In December 2023 the ACCC released a guide titled "Unfair Contract Terms in Franchise Agreements". In the guide the ACCC stated that while "Restraint of trade clauses are not inherently unfair", "they can often be framed in ways that raise concerns about UCT laws".
The ACCC indicated that franchisors should review their restraint clauses to ensure that they are only as broad as necessary to protect their legitimate interests, including reviewing the operation of cascading clauses.
A cascading clause (also known as a ladder clause) contains a number of alternatives, usually in relation to time (eg 2 years, 1 year, 6 months) and area (eg 3 km from the Premises, 2 km from the Premises, the Premises).
The way that cascading clauses have traditionally worked is that those parts of the restraint clause that are considered to be too broad and therefore unreasonable, can be removed from the clause.
However, the ACCC has cautioned that in its view, cascading clauses may lack transparency, and that restraints which go beyond what is reasonably necessary to protect the franchisor's legitimate interest are likely to be unfair.
2023 Review of the Franchising Code - Key Findings and Recommendations
The Independent Review of the Franchising Code of Conduct by Dr Michael Schaper also made comment on the application and effect of restraint of trade clauses in franchise agreements.
The review noted that unreasonable (and unenforceable) restraints of trade are unduly limiting franchisee opportunities at the end of a franchise relationship. Further stating that while many existing restraints of trade may be difficult to enforce, they may unduly inhibit and dissuade competition in the sector.
Consequently, the review recommended that the Government’s Competition Taskforce should consider how to limit the use of restraints of trade and other uncompetitive terms in franchise agreements.
Implications for Franchisees
Restraint of trade clauses can have significant implications for franchisees.
While these clauses may on their face, limit a franchisee's ability to pursue other business opportunities or work in the same industry after the termination of the franchise agreement, not all restraint of trade clauses will be enforceable.
We will have to wait and see what action the Government takes in response to the recommendation by the Independent Review that the Government should consider how to limit the use of restraints of trade in franchising.
It also remains to be seen whether the Courts will take a similar position to the ACCC and find that restraints which go beyond what is reasonably necessary to protect a franchisor's interests are unfair.
At the very least, the position taken by the ACCC allows franchisees greater leverage to negotiate reasonable terms for restraint of trade clauses.
Given that the refusal of franchisors to limit their restraint of trade clauses may lead to significant penalties if a Court determines that a restraint of trade clause is unfair, franchisees may be able to negotiate more reasonable terms both prior to their entry into the franchise agreement and on expiry or termination of the franchise agreement.
As discussed in our article Unfair Contract Terms, the maximum pecuniary penalties for each contravention of the unfair contract terms regime for companies are the greater of:
- $50 million;
- three times the value of the benefit (if able to be determined); or
- 30% of the company's adjusted turnover during the period of the breach, or the previous 12 months, whichever is longer.
Consequently, in order to avoid penalties Franchisors will need to consider:
- whether the franchise agreement in question is a standard form business contract [What is a Standard Form Contract?];
- what purpose the particular restraint of trade clause serves; and
- whether the restraint of trade clause is reasonably necessary to protect the franchisor's legitimate business interests*. For example, does the restraint of trade clause legitimately protect the clients of the franchise business or the goodwill in the franchise business arising from the intellectual property. An important factor to consider is whether there are other clauses in the franchise agreement (such as confidentiality or intellectual property clauses) that sufficiently protect the franchisor's legitimate business interest such that a restraint of trade clause is not necessary.
Tips for Franchisees to Navigate Restraint of Trade Clauses
Franchisees can take certain steps to navigate restraint of trade clauses effectively:
- Thoroughly review and understand the restraint of trade clauses before signing the franchise agreement.
- Seek legal advice to ensure the clauses are reasonable and enforceable.
- Negotiate for more favorable terms if the clauses are overly restrictive and arguably unfair.
- Explore alternative business opportunities that may not be covered by the restraint of trade clauses.
- Comply with any reasonable restraint of trade clauses during and after the term of the franchise agreement to avoid potential legal consequences.
Seeking Legal Advice and Support
Given the complexities surrounding restraint of trade clauses in franchising, franchisees should seek legal advice and support.
An experienced franchise lawyer can provide guidance on the interpretation and enforceability of these clauses, as well as assist in negotiating more favorable terms.
*For a discussion on what is a reasonable restraint of trade, please see our article Restraint of Trade Clauses in Franchise Agreements.
Disclaimer
The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.
