Summary
Restrictive covenants are the franchisor's key safeguard against franchisees who think they can do better outside, and at a cost to, the network. However, a recent judgment reminds us that they can be challenged in Court. Unless drafted carefully and kept up to date with the developing law, there is a risk that a covenant might not offer the protection which was originally intended.
Background
The franchisor in question, PSG Franchising Ltd
("PSG"), operated a business providing property searches
for conveyancers and lenders. Lydia Darby Ltd (the
"Franchisee") was a long-standing franchisee whose most
recent written franchise agreement had expired in March 2011,
although the parties continued to do business (apparently as
before) until the relationship was formally ended in August 2012.
PSG then discovered the Franchisee to have been operating a
competing business since September 2011 or earlier. It
applied for an injunction to stop the Franchisee from competing for
a period, based on the restrictive covenant in its franchise
agreement.
None of this is particularly unusual: most franchisors will find
themselves in a similar position at some point. The outcome
varies though, and depends greatly on the drafting of the agreement
in question.
Analysis
Here, the restrictive covenant sought to prevent the Franchisee,
for a year, from providing competing services in its former
franchise territory. There was also a restriction against
soliciting former customers of the franchised business. For
restrictive covenants to be reasonable (and thus enforceable) they
must be limited geographically and by time in a way which is
proportionate to the interest (such as its goodwill) that the
franchisor wants to protect. While PSG's covenant was
towards the more aggressive end of what is currently thought to be
allowed, it did fall within those boundaries.
Nonetheless, the drafting left enough room for the Franchisee to
argue in Court that the covenant was unreasonably broad and thus
unenforceable. The Franchisee contended that the clause in
fact stopped it competing anywhere in the UK where PSG operated,
and providing services developed in future which had never been
part of its own franchise. Happily for PSG, the Court ruled
that interpreting the clause required the application of commercial
common sense; the covenant meant what a reasonable person would
have understood it to mean. That was not the same as what the
Franchisee understood it to mean.
The Court also decided in PSG's favour the question of when the
restrictive covenants should start and end. The Franchisee
had argued that the covenants applied to it from the end of the
last written franchise agreement, in March 2011, and so expired in
March 2012. (Previous judges have expressed some support for
this line of thinking, which illustrates the dangers of franchisors
allowing franchisees to continue trading on when their agreement
has expired.) Again, though, this Court agreed with PSG and
decided that the covenants kicked in only after the franchise ended
in practice, in August 2012.
Conclusion
This judgment is a reminder that the effectiveness of franchise agreements can vary with time and can be called into question by a franchisee. Even if a franchise agreement was prepared by specialist lawyers like our franchising team, it is a modest (but invaluable) exercise each year to confirm that the agreement remains in line with the developing law. Similarly, if a difficult termination is approaching, particularly where franchisor and/or franchisee haven't done exactly what the agreement originally intended, the early identification of possible problems will help you to nip them in the bud before they present a risk to your business.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.