Can I stop a former franchisee from setting up a business that is similar to mine?

When a Franchisee enters into a Franchise Agreement there are general restraints prohibiting Franchisees from competing with the franchise business during the term and for a period after expiration of the term.

Restraint of Trade clauses are generally considered by courts to be anticompetitive and therefore unenforceable however they are recognised as being enforceable in limited circumstances such as the sale of a business (where the Vendor is prohibited from competing with the Purchaser) and Franchise Agreements.

Franchisors need to ensure their restraint and non compete provisions are carefully worded to be legally enforceable.

Contractual Restraints
Franchisees can be prevented from de-branding and setting up a competing business during the term and for a period after the expiry of the term.

Most Franchise Agreements contain a ‘covenant against competition’ or ‘restraint of trade’ clause to protect the Franchisor’s goodwill and prohibit Franchisees using the Franchisor’s know how.

A restraint clause will not be enforceable if it goes beyond what is considered reasonably necessary to protect the legitimate commercial interests of the Franchisor.

In an effort to ensure the widest possible protection many franchise agreements include a “cascading restraint clause”, which sets out a range of restraint areas and periods so that if the wider areas and/or periods are considered unreasonable by a court, the clause can be read down and enforced for a shorter period of time and/or within a smaller area. This reduces the risk to the Franchisor that the whole restraint clause will be unenforceable.

For example if a restraint clause seeks to prevent a Franchisee from competing for a period of 5 years after the termination of the agreement within 5 kilometres of every franchise outlet in the system, it is likely this would be considered unreasonable and therefore unenforceable. However, if an agreement contained a cascading restraint clause, the clause could be read down to a more reasonable level (e.g. 12 months and a 2 kilometre radius of the franchise site) that may be considered reasonable and therefore enforceable.

Protection of Franchisor’s Intellectual Property
Franchise Agreements grant franchisees a licence to use the Franchisor’s Intellectual Property. That right ceases upon the expiry or termination of the Franchise Agreement.

Franchisor’s can take action to prevent a Franchisee from infringing use of their Intellectual Property (name, logo, know how, recipes etc.)

Franchisors are also protected under the misleading and deceptive conduct provisions of the Competition and Consumer Act 2010 and can also rely on the Common Law passing off to restrain Franchisees from using the Franchisor’s confidential information or intellectual property and sell products or services under a name or logo deceptively similar to that of the Franchisor.

In order to take action against a Franchisee (or any third party) passing off their goods, services or brand as the Franchisor’s, the Franchisor will need to establish:

1. that it has a reputation in the jurisdiction (i.e. that it is well known in the market);
2. that the Franchisee’s conduct has been deceptive or might produce deception; and
3. that this conduct has damaged the franchisor’s reputation in the jurisdiction (in some cased the mere suggestion that the Franchisee is associated with the Franchisor may amount to damage).

Franchisors cannot however prevent a Franchisee from setting up a competing business outside of the restraint period and area provided they are not engaging in misleading and deceptive conduct or using the Franchisor’s intellectual property.