What you need to know about the validity and enforceability of a non-competition clause
The non-competition clause in your franchise, group or affiliate agreement is one of the most important provisions it contains. But does this restrictive covenant really protect you, or does it merely offer you the illusion of protection?
Based on our experience, in over half of the legal actions brought because of breaches of non-competition covenants, the courts have concluded that the clause is null because it does not meet the rigorous criteria for such covenants to be valid. Meanwhile, in many other cases, the courts have refused to enforce the covenant, mainly because it is not sufficiently clear.
What we have seen in recent years is a tightening of the criteria applied by the courts for deciding the validity of a non-competition clause and for enforcing it, including by issuing an injunction.
The courts have held that a non-competition clause will be found to be valid only if it is limited (as to duration, territory and the activities subject to it) to what is really necessary to protect the legitimate interests of the party for whose benefit it is enacted.
A non-competition clause must also be sufficiently clear so that the person giving the undertaking knows all the ins and outs of what he or she is agreeing to (including, again, in terms of duration, territory and the activities subject to it) at the time of signing.
A court that is asked to determine the validity of a non-competition clause may not change it (even if only to make it valid) or rewrite it. It has no choice but to either (i) declare it valid and enforceable, or, (ii) declare it null or unenforceable.
For a franchisor or a group, a judgment declaring a non-competition clause in its franchise, group or affiliate contract to be null or unenforceable may have disastrous consequences: such a decision taken by a court could apply to all the other franchisees, affiliates or members whose contracts contain the same clause or a clause similar to the one that has been declared null or unenforceable.
Therefore, how can you know whether your non-competition clause might be declared null or unenforceable by a court?
There are only two ways:
- to obtain a final judgment declaring it to be valid and enforceable (which may be a long and expensive process and, even worse, a very risky one), or;
- to have it reviewed by a lawyer who has experience with this type of clause and is familiar with the most recent case law (which is constantly evolving) that applies in this area.
Here are a few indicators that should strongly encourage you to have your non-competition clause reviewed immediately:
- If it applies for more than two years from the termination of the term of the agreement;
- If it has no territorial limit (even during the term of the agreement);
- If the territory subject to the non-competition covenant is larger than the market actually served by the points of sale in operation in your network;
- If the activities subject to the non-competition covenant are broader than the core business of your network's points of sale;
- If the wording of the clause is not very clear, if it requires evidence, or if it is open to more than one interpretation (for example, if your clause contains words such as "like" or "similar").
It is also important to ensure that everyone who should be bound by your non-competition covenants (including the franchisee's executives, directors, managers and shareholders) has signed it personally (and not just on behalf of the franchisee).
In any case, you should read your restrictive covenant over carefully, and also have it reviewed by your franchising or non-competition law counsel, at least once every two years.
Three practical tips
- Your agreement should provide severe consequences (for example, termination of the contract and a heavy penalty) for any breach of the non-competition covenants. The purpose of these consequences is primarily to deter your franchisee, member or affiliate from attempting to breach your non-competition clause, even when she/he believes (or her/his lawyer believes) that she/he has a chance of having it declared null or unenforceable.
- It is important that you read over your non-competition clause on a regular basis. This exercise is necessary to ensure that it still accurately reflects the activities of your points of sale and adequately covers (without going too far beyond it) the market served by your network (this is something that your franchise lawyer cannot know).
- It is preferable to have a clause that is narrower rather than broad in terms of duration, territory and activities subject to it. The narrower and clearer the clause, the better chance you have that it will be found to be valid and enforceable by a court.
In practice, breaches of non-competition covenants usually happen in (or near) the point of sale in question and in the first few months after the agreement terminates.
When it comes to non-competition clauses, the saying that applies is: "He who grasps at too much loses everything."
Today, in a world where the Internet is doing away with the concept of territory (since a manufacturer, distributor, retailer or service provider today can make sales all over the world, regardless of its physical location), drafting a non-competition clause that is both valid and genuinely useful is an increasingly delicate task. It is therefore particularly important to call on the services of real experts in non-competition clauses.