The cases of Cafe2U Pty Limited v Bishambu Pty Ltd1 and Health Club Brands Limited v Colven Botany Limited2 are examples of franchisees abandoning their franchise agreements and initiating new business ventures leveraging off the goodwill of the franchisor and demonstrate the importance of implementing effective restraint of trade clauses in franchising agreements.

Cafe2U Pty Limited v Bishambu Pty Ltd

Facts

‘Cafe2U Pty Ltd’ (Cafe2U) was the franchisor of mobile coffee vans throughout Australia. In 2011, Cafe2U entered into an agreement with the franchisee, Bishambu Pty Ltd (Bishambu) for a five year term.

Prince and Para, the sole shareholders and directors of Bishambu were appointed managers and undertook the initial training.

Cafe2U claimed that Bishambu breached its franchise agreement by failing to pay fees due and running a competing mobile coffee van. It also claimed that Bishambu had infringed copyright by setting up a website similar to that of Cafe2U. Cafe2U also claimed Prince and Para had engaged in misleading and deceptive behaviour and unconscionable conduct by pretending to be one other, duping senior employees of Cafe2U.

Shortly after the franchise agreement was signed, Bishambu ceased paying franchise fees claiming the business was not yielding enough profit. Mr Angelis, the National Operations Manager of Cafe2U undertook various internet searches that revealed links (“Likes”) on Prince’s Facebook page to “Coffee Van Melbourne” and “Coffee Mobile Van.” The Facebook entry for “Coffee Van Melbourne” contained a photograph of a coffee cart branded “Café metro.” The telephone number displayed on the cart was the same as listed in the franchise agreement between Cafe2U and Bishambu. The Café Metro website also listed the same phone number.

The website contained a menu link that looked very similar to Cafe2U’s menu. While the court recognised that mobile coffee vans would sell similar items, it was significant that the descriptions for the items were almost identical.

In September 2012, Cafe2U terminated the franchise agreement alleging Para and Prince had breached a clause in the agreement stipulating that they were prohibited from being involved in or carrying on any mobile food or beverage business anywhere in Australia during the term of the agreement.

Gross sales showed that the quantity of products that Bishambu had purchased from Cafe2U should have generated gross sales of over $97,000. Given the poor return to the franchised operations, the court considered it was likely that the products were being siphoned off for use in the Café Metro business.

The franchisor sought an interlocutory injunction preventing Para, Prince and Bishambu from continuing operations in Café Metro or carrying on any mobile food or beverage business similar to Cafe2U in the Glen Waverley area until 6 September 2013.

Decision

The Court awarded the injunction on the basis that the agreement was validly terminated. Further, the restraint of trade clause was reasonable since it only restricted the franchisees to the Glen Waverley area.

Justice Katzmann also found that Bishambu was fraudulent in connection with the operation of the franchised business under the Trade Practices (Industry Codes – Franchising) Regulations 1998 (Cth) as Para and Prince had pretended to be one another on many occasions.

Damages of $43,807.40 were awarded on the basis of fraudulent activity and the fact the franchisees had voluntary abandoned the franchise relationship.

Health Club Brands Limited v Colven Botany Limited

Facts

Health Club Brands Ltd (Health Club) was a franchisor of ‘Club Physical’ gyms across Auckland, New Zealand. Health Club entered into a franchising agreement with Colven Botany Limited (Colven), granting them the right to operate three ‘Club Physical’ gyms between 2009 and 2011.

In February 2013, Colven issued notices terminating each of the franchise agreements. Colven alleged they had been induced into entering the agreements by a misrepresentation that Health Club intended to honour all obligations under the agreements. Colven alleged Health Club had breached its ongoing assistance obligations under the agreements.

The notices of termination concluded that the franchisees would discontinue using the Club Physical name. The gyms were immediately rebranded as “Jolt Fitness” and continued trading.

Health Club claimed Colven’s actions amounted to repudiation of the franchise agreements and purported to cancel the agreement. They applied to the Court for an interim injunction to restrain Colven from conducting any health or fitness business within five kilometres of the premises formerly operated by them as a Club Physical gym.

Health Club relied on restraint of trade clauses in each of the franchise agreements to support the application. However, two of the agreements restraint of trade clauses were only partially complete as the duration and geographical distance specifications had been left blank. The third agreement had handwritten notes which suggested a 5km restraint for 2 years.

Since the termination, Health Club had contacted members of the three Jolt Fitness gyms in attempts to persuade them to revert back to Club Physical from Jolt. They had obtained the contact details from a Club Physical database created prior to termination. Colven then sought an injunction restraining this behaviour, alleging the information was confidential.

Issues

Three main issues were in dispute:

  • Were the restraint of trade clauses unenforceable as they were not fully completed by the parties?
  • Were the restraint of trade clauses unreasonable?
  • Are the Franchisees discharged from any obligation to comply with the restraints by the franchisor’s breach of contract?

Decision

The court held that the restraint of trade clauses were inconclusive since they were not complete, however, the Franchisor could rely on a separate clause allowing them to assign Colven’s three leases.

Colven’s challenge that the restraint was unreasonable since it served no legitimate business objective was unsuccessful. It was held that the Franchisee would continue to trade on the goodwill built up through access to the ‘Club Physical’ business model and that the franchisor had a legitimate interest in ensuring the transfer of that goodwill to an incoming franchisee.

The Judge found that if the franchisees were able to establish a breach of contract by Health Club justifying cancellation of the franchise agreement, they would not be bound by the restraint of trade. However, the evidence did not support any breach of the agreements by the franchisor. The fact the Colven felt they obtained a poor commercial bargain from the franchisor did not in itself confer a right to cancel.

The court granted an interim injunction restraining Colven from operating a health and fitness business from each of the three premises.

The counterclaim by Colven to restrain use of client details as the agreements contemplated a new franchisee stepping into the shoes of a previous franchisee in the event of termination. The judge found it a practical necessity for the franchisor to have access to details of existing customers.

Lessons for Franchisors

These cases highlight the need to have adequate restraint of trade clauses in franchising agreements to prevent a franchisee from operating a competing business. Franchisors need to consider what is reasonably necessary to protect their legitimate business interests. Poorly drafted clauses which are uncertain or unreasonable will often be unenforceable.

In considering what is reasonable, the court will look to the duration and geographic reach of the clause. The clause should contain multiple options (be cascading), so if one limitation is considered unreasonable, the restraint may still be enforceable for a lesser period or smaller geographic area.

The cases also demonstrate the importance of ensuring all clauses in a franchising agreement are fully complete, particularly when using precedent agreement packages.

Franchisors should also ensure there has been a valid termination of the franchise agreement before attempting to enforce a restraint of trade clause.

Lessons for Franchisees

Franchisees should be aware of the implications of restraint of trade clauses before signing franchise agreements. Even after the franchise agreement has been terminated, the restraint of trade clause will usually continue to operate.

This may have a substantial impact on the earning ability of an ex franchisee that brings particular skills to the franchise relationship.

Franchisees should also be aware that a breach of the franchising agreement by the franchisor may be grounds to invalidate the clause.