Can the franchisee be forced to work exclusively in the business?
Interestingly, such restraints often do not contain the same limitations on their scope as you expect to see in relation to a restraint that has application post termination or expiry. In particular, restraints during the terms of a franchise agreement often do not contain geographic limitations and do not limit themselves to restraint of activities that are similar to or competitive with the franchise businesses.
Are these restraints enforceable?
Restraints relying on unsafe authority
Prior to 2001 there was authority for the proposition that in respect of agreements, the commercial objectives of which required the absorption of a party’s services, a different test in relation to restraints applied [1]. According to that UK authority, restraints during the term of such an agreement do not attract the common law doctrine of restraint of trade and need not be reasonable to be enforceable. .
This historic position may explain the lack of qualification on the scope of the restraints found in many franchise agreements.
The application of the test of reasonableness
The High Court in Peters (WA) Ltd v Petersville Ltd and Anor [2] (the Petersville decision) decided that the UK test referred to above should not be accepted in Australia common law. Following that decision, the position in Australia is that restraints during the term of an agreement are subject to a test of reasonableness.
This means that unless the franchisor can show the restraint preventing the franchisee from working outside the franchise business during the term of the franchise agreement is reasonable, it will be unenforceable[3].
Protection of legitimate interests
In determining the reasonableness of a provision the courts generally have regard to the legitimate interests of the parties [4]. Courts are willing to enforce restraints provided they are no more broad than is necessary to protect the legitimate interests of the party seeking to rely on the restraint.
In considering the reasonableness of restraints in the context of a franchise agreement, the recent case of Raine and Horne Pty Ltd v Adacol Pty Ltd & Ors [5] gives some guidance as follows:
- Franchisors have an interest in protecting the patronage built up through the operation of the franchise, which may be lost if the franchisee is permitted to compete without restriction.
- Franchisors have an interest in preserving the confidentiality of confidential information provided to the franchisee, which could be used by the franchisee to compete with the franchisor if there were not restraint.
- The franchisee has an interest in protecting the goodwill of its own business.
- The customers of the franchisee’s business are customers of the franchisee’s business, though the franchisor also has an “interest” in the customers since they are attracted to the franchised business.
- The question is whether the restraint clause is too wide, given the nature of the franchisor’s interest and the need to balance the interests of the franchisor and the franchisee.
Whether or not the franchisor is able to require a specific person to devote all of their time to the franchise will depend upon how the court characterises the franchisor’s legitimate interest. if it is fundamental to the operation of the franchise that a particular individual has hands on, day to day, operations responsibility and control of the business then it is arguable that the franchisor needs a broad restraint to protect his / hers legitimate business interests.
However, if a franchisee holds more than one franchise it will be difficult to argue that it is fundamental that the franchisee devotes their time, hands on, in both franchises based solely on the standard unit franchise agreement. In those circumstances separate multi-site agreements with specifically drafted restraints may be necessary.
Conclusion
Franchisors need to draft the restraints around the facts and circumstances of their business, not a precedent document. It is important not to assume franchisors are always entitled to restrain the franchisee from engaging in investment, business and employment opportunities outside the franchise.
Review your franchise agreements regularly. Many franchise agreements drafted before 2001 will contain restrains bases on outdated authority and consequently will be less likely to be enforceable.
By Warren Scott, Partner - Mills Oakley lawyers
[2] (2001) 181 ALR 337.
[3] Peters (WA) Ltd v Petersville Ltd and Anor (2001) 181 ALR 337.
[4] Peters (WA) Ltd v Petersville Ltd and Anor (2001) 181 ALR 337.
[5] [2006] NSWSC 36.
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