Any franchisor who has tried to enforce a restraint of trade clause against a former franchisee will have received legal advice that restraints are unenforceable unless they can be shown to be reasonably necessary to protect the franchisor’s legitimate business interests. Usually, the examination of reasonableness focuses on the time duration of the restraint, the geographic area of the restraint and the activities that are being restrained.
However, a recent court decision serves as a timely reminder that time, area and activities are not the only considerations when assessing reasonableness. In EzyDVD Pty Ltd v Lahrs Investments Qld Pty Ltd, a decision of the Queensland Supreme Court, EzyDVD (the franchisor) sought to enforce a restraint in a franchise agreement. Immediately after the defendant’s EzyDVD franchise had terminated, one of the directors of the defendant had started up a new company that ran a competitive business from the same location.
The wording of the restraint clause was the problem. The restraint in the franchise agreement provided that because the franchisee had access to the franchisor’s intellectual property, it was agreed to be reasonable to restrain the franchisee and the guarantors (described in the restraint as Control Persons) from operating a competing business within 5km of the franchise premises for 6 months after the franchise agreement terminated. The franchise agreement also provided a comprehensive “delivery up” regime whereby the franchisor’s intellectual property had to be delivered up or destroyed at the end of the franchise agreement. It was accepted that the franchisee complied with its “delivery up” obligation, but the franchisor complained that the guarantor would retain some of the intellectual property in his memory and may use that information, even subconsciously, in the new business. For this reason it was argued that it was necessary to impose the restraint.
The Court rejected this argument and said that the “delivery up” regime was sufficient to protect the franchisor’s intellectual property. Whatever intellectual property was retained in the mind of the guarantor was unlikely to be exploited in the new business. The Court said that it was unreasonable to impose the restraint when there was another way (the “delivery up” regime) to protect the franchisor.
For franchisors, while the primary focus of the Court’s decision provides little comfort, there were two other interesting points that arose out of this decision. Firstly, without making a concluded finding to this effect, the Court appeared to accept that even though the guarantor signed the franchise agreement as guarantor only, he would still be bound by the restraint (the guarantor not having signed a separate covenant agreeing to a restraint of trade). Secondly, the fact that the franchisee had to obtain independent legal advice before entering into the franchise agreement was a significant matter in determining whether it was reasonable to enforce the time and distance elements of the restraint.
The decision in EzyDVD emphasises the need to properly consider the terms of any restraint that you want to impose on your franchisees. A carefully worded restraint may still be enforceable, but the courts will always critically examine the entire contractual relationship before enforcing a restraint.