Franchising is an excellent way for a business to grow its commercial activity. However, as a franchisor, you need a franchise agreement to regulate your relationship with franchisees. One necessary clause in a franchise agreement is a restraint of trade clause. These clauses can be very fact-specific and complex. Therefore, it is worthwhile to duly consider their effect when you are evaluating a franchise agreement. This article will explain whether a restraint of trade clause can bind former franchisees.
This publication provides you with the fundamentals for franchising your New Zealand business, including set up, branding and management.
Leaving a Franchise
Franchising is a method for business growth in New Zealand. A franchisor manages an overall system, while franchisees manage smaller installations of a successful business in discrete locations across the country. The franchisor provides their franchisees with various forms of support, while franchisees pay various royalties and fees in return.
However, franchise relationships do not last forever. A franchisee will sign on for a set period. When that time is over, they no longer retain the same powers as franchisees. At this time, franchisees can leave or renew their rights to continue their franchise relationship.
Notably, while the overall franchise relationship may be over when a franchisee leaves, that does not mean they no longer have obligations to fulfil. In this case, the clause may apply to former franchisees.
What is a Restraint of Trade Clause?
The clauses within a franchise agreement will detail exactly what happens upon the termination of the agreement and the obligations of both parties.
One of these may be a restraint of trade clause. It is a standard commercial tool that franchisors may use to protect their intellectual property and goodwill after a franchisee terminates their agreement. Most franchise agreements will likely contain some variation of a restraint of trade clause.
Continue reading this article below the formWhat Does a Restraint of Trade Clause Do?
A restraint of trade clause imposes certain limitations on the franchisee after they leave the franchise. These restraints can affect:
- whether a former franchisee can compete in the same industry or system as the franchisor;
- where a former franchisee can do business in terms of location; or
- whether a franchisee can contact previous clients of theirs for their business activity.
As an exiting franchisee, you have intimate knowledge of how your previous franchise works. Therefore, to protect their goodwill and franchise brand, franchisors will use restraint of trade clauses to limit the use of that knowledge.
How Long Do Restraint of Trade Clauses Last?
The length of these restrictions will depend on what the clause itself specifies. Further, it will depend on the terms of the franchise agreement itself. Typically, it will be for a set period after you leave. However, this clause can only last as long as it is a reasonable restriction on you as an exiting franchisee. The following paragraph will go more into this point.
Can a Restraint of Trade Clause Bind Former Franchisees?
A restraint of trade clause is not enforceable in a court of law. However, if your franchisor can prove that their controls on your trade are reasonable, then you will need to abide by its rules. Typically, this clause will be reasonable if your franchisor can prove that it:
- is justified by a protectable interest; and
- does not extend past what is reasonably necessary to protect that interest.
When deciding whether to justify the restraint of trade clause, the Court will consider the nature of the business and your experience as a franchisee. If the franchisor did not provide you with much support, and you ultimately relied on your know-how to run the franchise, then a restraint of trade clause may not be reasonable in this case.
Key Takeaways
Restraint of trade clauses set specific restrictions that a franchisor may impose on franchisees after they leave their franchise system. To enforce such a clause, a franchisor must establish that it is reasonable to impose these restrictions. This process will be highly context-dependent and rely on the nature of the franchise itself and you as a franchisee.
If you need help understanding a restraint of trade clause, our experienced franchising lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 0800 005 570 or visit our membership page.
Frequently Asked Questions
A franchise is a business model you may use to grow your business. As the franchisor, you will allow other parties, the franchisees, to replicate your business operations to create their success. In return, you grow your brand and receive various fees or royalties.
A restraint of trade clause is a clause you may find in your franchise agreement. It imposes certain restrictions on your ability to engage in commercial activity that may compete with your previous franchise.
We appreciate your feedback – your submission has been successfully received.
