Franchising

Post Restrictive Covenants – How far can you restrict franchisees?

We are asked frequently by franchisors how far they can go to restrict a franchisee from competing with their businesses during and after termination of the franchise agreement.

In the recent decision of Carewatch Care Services Limited v Focus Caring Services Limited and others, the High Court has given guidance on what restrictions may be reasonable.

Carewatch is the second largest provider of home care services in the UK. It operates through a combination of directly-owned corporate branches and outlets run by franchisees. Over the last five years, the balance has shifted significantly from the franchise side of the business towards an increase in directly owned branches. As a consequence, a considerable number of Carewatch’s franchisees have, it appears, become increasingly dissatisfied with the support they have received and suspicious that Carewatch was deliberately trying to run down the franchise side of its operations in favour of its own branches.

After the expiry of the original franchise agreement, a number of franchisees were continuing to trade whilst attempting to negotiate a fresh agreement. However, matters came to a head at the start of this year when Focus (one of the franchisees) wrote to Carewatch to assert that Carewatch was in repudiatory breach of implied terms and accepted those breaches and claimed that they were discharged from their post-termination covenants which, for good measure, they said were unenforceable in any event.

Carewatch issued proceedings to enforce the covenants and the case was brought on for a very speedy trial.

The main findings of general relevance in the case were as follows:

  1. The Defendants argued that as franchise agreements require “a significant commitment of time, money, mutual trust, confidence and loyalty between the parties” certain terms should be implied into the agreement including: (i) to enable Focus to carry on business with a view to making profit as a franchisee; (ii) Carewatch should work to improve and develop the franchise network for the mutual benefit of both parties; and (iii) the parties should act in good faith and deal with each other fairly. The judge reviewed the leading cases on implied terms and highlighted that he should only imply such terms where there is a “clear lacuna” in the contract and the term is necessary to make the contract work. In fact, he referred to one case where the judge declined to imply a term of trust and confidence into a four year highway maintenance contract, and another case where the Court did not imply an obligation of good faith. On the facts, the Judge held that as the franchise agreement was very detailed, there was no “clear lacuna” in those detailed provisions and so it was not necessary to imply such terms. He also made it clear that the terms suggested by the Defendants were “framed in such wide and imprecise language”.
  2. Carewatch was not in repudiatory breach of the agreement. In particular, Carewatch: (i) did not breach any implied terms; (ii) was not required to extend the term of the agreement as no notice was given under the renewal provision; (iii) the new agreement offered was indeed Carewatch’s then current standard form and the fact that it was not presently being offered to new franchisees was immaterial; (iv) was under no obligation to extend the franchise network further; and (v) was supporting the franchise business and network by the provision of regularly updated policies and procedures. The judge found that that the allegations to the contrary were “hopeless on the facts”.
  3. The basic position under law is that restrictive covenants in restraint of trade are contrary to public policy and accordingly prima facie unenforceable. The only way they can be enforced is if Carewatch can show that they were designed to protect its legitimate business interests and they went no further than necessary to achieve that purpose. In this case, the restrictive covenants prevented the franchisees from doing the following:
    1. for 12 months after termination be engaged in, employed by or be concerned or interested directly or indirectly in any business which competes with the Business or the Franchisee’s business or in any business similar to the Business in the Territory;
    2. for 9 months after termination be engaged in, employed by or concerned or interested directly or indirectly in….. any business similar to the Business within the Territory of another franchisee of the Franchisor and in which a customer of the Franchisee shall have its address or place of business;
    3. for 12 months after termination indirectly or directly solicit or tout for business from customers who were customers of the Franchisee at any time in the 12 months period prior to termination; and
    4. for 12 months from termination indirectly or directly solicit, interfere with or endeavour to entice away or employ any employee of the Franchisor or any of the Franchisor’s franchisees or any employee which in the period of 6 months before the said termination was an employee of the Franchisee’s Business.
  4. The judge highlighted that the legitimate interests of the franchisor could include protecting the goodwill, confidential information, know how, employees and customers of the business. With respect to the covenants above, the judge noted that the parties agreed that the durations were reasonable and he held that they were all necessary to protect the legitimate interests of the franchisor. In particular, he found that in relation to the 12 month non-compete provision at [i] above its limitation to similar businesses within the franchise territory kept it reasonable and that the 9 month non-compete clause at [ii] above that was reasonable bearing in mind its narrow scope. A franchisor has a legitimate interest in preventing competition by a former franchisee against its other franchisees and retaining customer loyalty.
  5. He therefore found that the restrictive covenants were not a restraint of trade and, as a consequence of his finding, they were not anti-competitive.
  6. When considering competition law, he highlighted some important sections in the “Pronuptia” case including: “Franchise agreements for the distribution of goods differ in that regard from dealerships or contracts which incorporate approved retailers into a selective distribution system, which do not involve the use of a single business name, the application of uniform business methods or the payment of royalties in return for the benefits granted. Such a system, which allows the franchisor to profit from his success, does not in itself interfere with competition”.

Pronuptia (a decision of the ECJ in Case 161/84 Pronuptia de Paris GmbH v Pronuptia de Paris Ermgard Schillgalis [1986] ECR I-353) held that it was legitimate in a franchise agreement to include provisions to protect know how in order to prevent a franchisee during the contract and for a reasonable period afterwards from opening a shop of the same or similar nature in an area where he may compete with a member of the network.

Therefore, the judge found that all the defences raised by the Defendants failed. Carewatch was entitled to injunctive relief to enforce the restrictive covenants and the step in provisions (which allowed Carewatch to take control of the Defendants’ business and pay a market rate for the assets). Further, Carewatch was entitled to damages against all three Defendants.

Peter Swinburn, a member of the Franchise Team at Clarke Willmott said, “This case highlights that franchisors have the ability to include quite extensive post termination provisions in franchise agreements to protect their legitimate business interests, and it is going to be very difficult for franchisees to argue that certain obligations on the franchisor can be implied into a very detailed franchise agreement. From the franchisee’s perspective, it is key to take independent legal advice to ensure that it understands the scope of any restrictions in the agreement and avoids the risk of either having the agreement terminated or being liable for damages as a result of a breach of the agreement”.

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