Why a non-compete clause is key to keeping a company’s IP safe

Non-compete clauses are essential to protect a franchisor from franchisees using its secret sauce to set up in opposition. But how can franchises ensure their terms are valid?

Why a non-compete clause is key to keeping a company’s IP safe

In the economy, as in sport, competition is generally considered to be a good thing. As a result, we have a variety of laws that prohibit commercial agreements that restrict competition. Despite this, all franchise agreements contain terms that prevent franchisees from setting up in competition.”

These provisions go by many different names: ‘non-compete clauses’, ‘restrictive covenants’, ‘restraint of trade’. Call them what you will, the effect is the same. They are provisions that seek to prevent the franchisee operating a business that competes with the franchisor or the wider franchise network. But what kinds of restriction are typically found in franchise agreements? And in what circumstances will they be valid?

Types of restriction

Franchisees gain a lot of confidential information during their time with a network and most people would agree that it would be unfair for the franchisee to be able to use that information to compete with the franchisor. In light of this, all franchise agreements contain restrictions that seek to prevent the franchisee from engaging in a competing business. Typically, these restrictions will include not being involved, in any capacity, in a competing business and not soliciting employees or customers of the franchise. And they usually apply both whilst the franchisee is operating the franchise business and for a period of time after the franchise agreement ends.

General rule

The general rule is that any restriction that prevents competition is unenforceable. But before you get excited and rip up your franchise agreement, there are certain circumstances where the clauses will be valid. Specifically these are when there is a legitimate business interest that needs to be protected; the restrictions don’t go any further than is reasonably required to protect that interest; and the restrictions are not against the public interest.

The franchisor’s know-how, business contacts and the difficulty of recruiting a replacement franchisee if the old franchisee is allowed to compete freely are all legitimate interests that the franchisor is entitled to protect.

What’s the wiggle room?

The wider the scope of the restriction – considering the time period, geographical areas in which the restrictions apply and the nature of the restricted acts – the more unreasonable it becomes. A restriction that is too wide will be entirely unenforceable. The big difficulty with this is that what the franchisor thinks is reasonable will probably be considered unreasonable by the franchisee.

The courts’ general view is that the people who are best placed to decide whether something is reasonable are the parties themselves, so if the parties have agreed that the provision is reasonable, the courts will be reluctant to interfere. As a result, franchise agreements will often contain a clause where both sides agree that the provisions are considered reasonable.

What if a clause is too wide?

Typically, franchisors will want to include restrictions that are as wide as possible for maximum protection but if a clause is too wide then it will be invalid and unenforceable. The franchisor will often hedge their bets by including a series of very similar clauses but with a slightly different time period or geographical area in each one. The advantage of this is that if one of the clauses is too wide to be enforceable, then the franchisor can fall back on the next one with a slightly smaller scope.

The stakes are high

When it comes to enforcement of restrictive covenants, both sides have much at stake. If the franchisor doesn’t enforce the clause, they risk other franchisees in their network thinking it’s okay to set up an independent business using the knowledge gained from the franchisor. Equally, a franchisee who has worked in a particular industry for many years may be at a loss as to how to earn a living if they can’t continue to be involved in that industry after the franchise agreement ends. The high stakes mean that this is fruitful ground for litigation and several franchise cases have been taken to court over recent years.

Overall, the courts have shown that they are generally willing to enforce non-compete restrictions in franchise agreements, recognising that the franchisor does have a legitimate interest that needs to be protected – as long as the clause is not too wide.

The generally accepted view is that restrictions lasting up to a year are almost certainly valid. Equally, a restriction that applies in the franchisee’s territory is almost certainly valid. The position is less clear cut when it comes to restrictions that apply in wider areas or for longer time periods. In that situation, the courts will look at all of the relevant facts and circumstances, including what knowledge the franchisee has learnt during their time with the network and how widely the network operates.

Ultimately, the best advice for franchisors is to clearly identify the interests that you want to protect and choose restrictions that protect them – but no more. Meanwhile, a good rule of thumb for franchisees is to assume when you sign your franchise agreement that the non-compete clauses will be valid. If you’re not prepared to accept the restrictions, don’t sign up.”

Kate Legg
Kate Legg