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Restraint of trade clauses are included in franchise agreements to stop the franchisee from competing with the franchisor, during the term of the franchise agreement, and after the franchise agreement ends.
A restraint of trade clause will not necessarily apply or be enforceable. Consequently, franchise disputes often arise over the enforcement of restraints.
Contents
Restraint of Trade Clause has No Effect
Restraints are Contrary to Public Policy
What is a Legitimate Interest?
Is the Restraint of Trade Clause Protecting a Legitimate Interest?
Is the Restraint of Trade Clause Reasonable?
Restraint of Trade Clauses in New South Wales
From 1 April 2025 a franchisor must not enter into a franchise agreement that includes a restraint of trade that would apply in the circumstances set out in section 42 of the Franchising Code of Conduct [What is the Franchising Code of Conduct?].
Broadly, the franchise agreement must have expired, before the expiry the franchisee must have sought to renew or extend the franchise agreement, and the franchise agreement must not allow the franchisee to seek compensation for goodwill, or alternatively, if the franchise agreement allows the franchisee to seek compensation for goodwill, the compensation must be inadequate.
For franchise agreements entered into prior to 1 April 2025, clause 23 of the previous Franchising Code of Conduct (the previous Franchising Code) sets out a series of circumstances in which a restraint of trade clause contained in a franchise agreement has no effect after the franchise agreement expires.
That is, in certain circumstances, after the franchise agreement expires, the franchisor cannot stop the franchisee from competing with the franchisor.
Broadly, the franchise agreement must have expired and the franchise agreement must not allow the franchisee to seek compensation for goodwill, or alternatively, if the franchise agreement allows the franchisee to seek compensation for goodwill, the compensation must be inadequate.
Except for franchise agreements where New South Wales law is applicable, restraints of trade are contrary to public policy and void unless they can be justified as being reasonable. In New South Wales the Courts can determine what would be reasonable in the circumstances (and read down the restraint of trade clause so that it is reasonable).
“Reasonable” in this context means that the restraint provides no more than adequate protection to the person seeking to enforce the restraint.
The reasonableness of the restraint is determined at the date of entry into the franchise agreement.
This means that if a franchisor wishes to stop a franchisee from competing with the franchisor (ie the franchisor wishes to enforce the restraint clause) the franchisor would need to convince a Court that at the date that the franchise agreement was entered into, the restraint of trade clause was reasonable and necessary to protect the franchisor's "legitimate interests".
At the same time, a restraint of trade clause cannot be against the public interest. Consequently, a restraint of trade clause cannot unfairly limit competition or prevent someone from working.
It has long been held that for a restraint to be reasonable, the party trying to enforce the restraint "must establish an identifiable interest calling for protection1". This "identifiable interest" is known as a legitimate interest.
Common examples of a legitimate interest which can be protected include, goodwill, customers and confidential information.
However, while a restraint clause may say that the legitimate interest that the party is trying to protect is one or more of goodwill, customers or confidential information, a Court will make its own assessment of whether there is a legitimate interest to protect.
Further, "legitimate interest" is not confined to goodwill, customers, or confidential information and can be construed more broadly.
In the Victorian case of Kingdom Animalia LLC v Mecca Brands Pty Ltd (ACN 077 859 931) [2023] VCSA 55, the Victorian Supreme Court considered some of the broader findings of legitimate interest2 including:
In franchising, goodwill is commonly sought to be protected through the use of a restraint of trade clause or agreement.
In Chipsaway International Ltd v Kerr [2009] EWCA Civ 320, the Court considered the protection of goodwill and stated:
"... during the term of a franchise, goodwill is built up in the franchise territory with use of a franchisor's name and branding. Such goodwill is a potentially valuable asset in the hands of the franchisee so long as he continues to trade in the franchise territory, and in the hands of the franchisor at the termination of the franchise agreement. A franchisor's interest in that goodwill is vulnerable to competition from a former franchisee who has knowledge of the area and experience of dealing with particular groups of customers. The commercial purpose of a post-termination covenant against competition is to prevent the franchisee for a period of time from continuing and competing in his former territory in the same line of business so as to enable the franchisor to exploit the goodwill that he has built up during the term, most obviously by recruiting another franchisee for the same area".
In KA & C Smith Pty Ltd v Ward (1998) 45 NSWLR 702 at 723-724, Austin J considered:
"To preserve the franchisor's "goodwill" (referred to above as an interest in the patronage of the franchised business and the confidentiality of products and processes), the franchisor needs time to obtain a substitute franchisee to work the franchise area, and the new franchisee needs time to become established. Direct competition by the former franchisee would be likely to damage the transition process."
Confidential Information is another example of a legitimate interest that is often sought to be protected in franchising by the use of a restraint of trade clause.
In Narellan Franchise Pty Ltd v RBME Pty Ltd [2022] NSWSC 988 Richmond J stated at 48
"In the context of a franchise agreement, the legitimate interests which are capable of protection by a post-contract restraint of the kind found in cl 12.5(b) include the franchisor's confidential information and knowhow, and goodwill."
Confidentiality agreements or clauses can also be restraints of trade. For a discussion about enforceable confidentiality agreements see our article Confidentiality Agreements: A Comprehensive Guide.
While a restraint of trade clause may state the "legitimate interest" that the clause is trying to protect ie goodwill or confidential information, a Court will assess whether in the particular facts of the case, (at the time that the agreement was entered into) there is a legitimate interest and whether it is capable of protection.
In assessing the reasonableness of a restraint of trade clause, courts generally adopt a cautious approach, only upholding such clauses when they are justifiable to protect the legitimate interests of the franchisor.
We have set out below two cases where the Court held that there was no legitimate interest to protect and accordingly the restraint of trade clause in each case was not enforceable.
In this case the franchise agreement was terminated after the franchisee had operated the franchise business for a year and a half. The franchisee (using a different corporate entity), immediately commenced operating a similar business from the same premises. The franchisor sought to enforce the restraint of trade clause in the franchise agreement.
The restraint of trade clause:
The franchise agreement also contained provisions dealing with the confidentiality of the franchisor's information and the protection of the franchisor's intellectual property on termination of the franchise agreement. The franchisee had complied with these provisions.
The Court found that it was not reasonable for the franchisor to enforce the restraint of trade provisions given that:
In this case the franchisees operated Blockbuster video/dvd stores in Noosaville and Nambour in Queensland for a period of approximately 10 years. After the respective Blockbuster franchise agreements expired, the franchisees continued to operate the businesses under a different name.
Relevantly, the franchisees had prior to their entry into the Blockbuster franchise agreements, operated video stores under a different brand at each of the franchised locations.
Blockbuster did not purchase the goodwill in these businesses when the franchisees entered into the Blockbuster franchise agreements.
After the Blockbuster franchise agreements expired, the franchisor tried to stop the franchisees from operating the businesses and sought to enforce the restraint of trade clauses included in the respective franchise agreements.
The franchisor indicated that the legitimate interest that it was seeking to protect through the respective restraint of trade clauses was "goodwill".
The Court made an assessment of the goodwill owned by each of the franchisees and the franchisor in the businesses at the date that the franchise agreements were entered into. While the franchisees had significant goodwill in the businesses (as the businesses had already been operating under a different brand), the only goodwill that the franchisor had at the time that the parties entered into the agreements was the goodwill in the "Blockbuster" brand (the franchisor had not purchased the franchisee's goodwill). However, the goodwill in the "Blockbuster" brand existed independently of the businesses. Consequently, at the date that the franchise agreements were entered into, the franchisor had no legitimate interest to protect.
The Court also found that to the extent that during the currency of the franchise agreements the parties expected Blockbuster to acquire goodwill in connection with the businesses as a result of the use of the Blockbuster Systems in the businesses, Blockbuster further had no legitimate interest to protect because the franchisees could not use any part of the Blockbuster System after the expiry of the franchise agreements.
If there is a legitimate interest to protect, the Court will then assess whether the restraint of trade clause provides no more than reasonable protection.
Restraint of trade clauses are usually restricted by - activity (eg. you can't open a competing business) - geographical limits (eg. not being able to open a business within a 5km radius of the franchise business) - time (eg. 12 months).
Whether a restraint of trade clause is reasonable is usually considered by looking at:
If a restraint of trade clause is drafted too widely, or if there is another way to protect the legitimate interests of the party trying to enforce the restraint of trade clause, the clause may not be enforceable.
A cascading provision is a provision which includes a number of alternatives, usually in relation to time (eg 2 years, 1 year, 6 months) and area (eg Australia, State, Territory).
It is common to see cascading provisions included in restraint of trade clauses.
The idea of a cascading provison is that those parts of the restraint clause that are considered to be unreasonable because the time period is too long or the area is too large are severed (deleted) from the clause.
However, just because a restraint of trade clause is read down to the shortest time period and the smallest area, does not mean that it will automatically be valid.
The restraint was a cascading clause providing that the franchisee could not operate a similar business, within the franchisee's territory or within a 5 km radius of the franchisee's territory, or within the territory of another franchisee, or within a 5km radius of that territory.
The smallest area covered by the restraint was the franchisee's territory. The franchisee's territory was a large area which was sparsely populated.
The Court found that there was no evidence that the franchisee was known in large parts of the territory and found that the geographical area of the restraint was too wide.
The restraint was unenforceable and the franchisee was allowed to operate a competing business.
In New South Wales it is not strictly correct to say that a restraint is against public policy and void. As a result of the Restraints of Trade Act 1976 (NSW) a restraint is valid to the extent that it is not against public policy.
In New South Wales, in order to determine whether the restraint is valid, the actual alleged breach is considered, rather than the restraint of trade clause as a whole.
If the alleged breach is not against public policy, the Supreme Court has the power to "read down" the restraint of trade clause, in certain circumstances if the clause is not reasonable.
In Narellan Franchise Pty Ltd v RBME Pty Ltd [2022] NSWSC 988 Richmond J stated at [61] the correct approach to the application of s4(1) of the Restraints of Trade Act:
"the court determines whether the alleged breach (independently of public policy considerations) does or will infringe the terms of the restraint properly construed. Next, the court determines whether the restraint, so far as it applies to that breach, is contrary to public policy. If it is not, the restraint is valid, subject to any order which may be made under s4(3)."
The Court considered certain principles to be applied when considering whether a restraint of trade clause is valid:
Restraint of trade clauses are complex. Just because a franchise agreement contains a restraint of trade clause does not mean that the clause will apply or will be enforceable.
When drafting a restraint of trade clause the particular circumstances of the franchise system must be considered. Standard clauses are unlikely to be enforced by a Court.
1. Jaddcal Pty Ltd v Minson [No 3][2011] WASC 362
2. Kingdom Animalia LLC v Mecca Brands Pty Ltd (ACN 077 859 931) [2023] VCSA 55 at 39
3. Peters American Delicacy Co Ltd v Patricia's Chocolates and Candies Pty Ltd [1947] HCA 62 at 581
4. Peters American Delicacy Co Ltd v Patricia's Chocolates and Candies Pty Ltd [1947] HCA 62 at 582
5. Peters American Delicacy Co Ltd v Patricia's Chocolates and Candies Pty Ltd [1947] HCA 62 at 599
6. Amoco Australia Pty Ltd v Rocca Bros Motor Engineering Co Pty Ltd (1973) 133 CLR 288 at 308
7. Queensland Co-operative Milling Association v Pamag Pty Ltd (1973) 133 CLR 260 at 268
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.
A key aspect of the Amendment (Closing Loopholes) Act 2023 is the criminalisation of ‘wage theft’....
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