Franchising - take care at the end of the road

When a franchise agreement comes to an end, franchisors need to ensure that they have protected their business by securing a promise from the franchisee not to compete at the end of the agreement, warns Dorothy Agnew, Senior Solicitor at Moore Blatch. 

Such restrictions need to be addressed as a restrictive covenant within the franchise agreement. However, a recent case has shown that care must be taken to avoid a lack of clarity when drafting such restrictions.

In the case of Chipsaway International Limited v Kerr 2009, two courts agreed that there was an error in the drafting of a restrictive covenant but reached two different conclusions over its interpretation. 

The Court of Appeal has now ruled that a former franchisee who operated his own car service business following the termination of a franchise agreement was acting in breach of restrictive covenant, despite the fact that the franchisor had no other businesses in that territory.

Chipsaway owned rights to and know-how in a system for filling and restoring damage to the bodywork of cars, and also supplied products used in the system. It franchised rights to use its name, paints and other products. Kerr, a franchisee, decided not to renew his franchise agreement.  Kerr ceased to use the ChipsAway name or any of Chipsaway’s products but continued to carry on his business as a car care centre, including a damage repair service, at the same premises. Chipsaway claimed that Kerr was in breach of the restrictive covenant in the franchise agreement which prohibited him, for the period of 12 months following the termination of the agreement, without Chipsaway’s prior written consent, from competing with the business within the area.

The original ruling in the High Court saw the judge rule that the franchisee was restrained from engaging in any competing business only when a new franchisee was in the territory and as there was no new franchisee, there was no competing business in the area and therefore no breach of the covenant.  On appeal, this interpretation was rejected and it was decided that in fact the commercial purpose of the restrictive covenant was to allow the franchisor some breathing space to find a new franchisee and protect franchisor’s goodwill – no actual competition was required.  The High Court decision was reversed and the franchisee was held to have acted in breach of the restrictive covenant.

During the term of a franchise, a franchisee will likely to have built up significant and valuable goodwill in the franchise territory through the use of the franchisor’s name, branding, confidential information and other intellectual property rights.  The franchisee’s knowledge of the market and other skills developed through operating the franchise puts them in a good position to compete with the franchisor or any replacement franchisee at the end of the franchise agreement.  This may make it difficult for a franchisor to attract a new franchisee to the territory.  Therefore, franchisors should think seriously about securing a promise from the franchisee that the franchisee will not engage in a competing business for a period of time after the franchise agreement ends. 

As this case has shown, care must be taken when drafting restrictive covenants to avoid a lack of clarity.  Not having a properly drafted and watertight agreement could result in the unwanted burden for the franchisor having to spend time and money arguing over the meaning of a poorly drafted restrictive covenant and at worst could find that the covenant is unenforceable.

Moore Blatch has a team of experts who can advise both franchisors and franchisees on the legal aspects of running a franchise operation.