Franchisee breaks restrictive covenant

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Franchisee breaks restrictive covenant

A franchisee broke a restrictive convenant. This prevented them engaging in a competing business, once the franchise agreement terminated. Our client, the franchisor, enforced this restrictive convenant, to protect their goodwill.

How we reduced risks

On behalf of the franchisor, we:

  • Assisted with the interpretation of the franchise agreement.
  • Enforced the restrictive covenant.
  • Obtained an injunction that prevented the franchisee from damaging our client’s brand and goodwill.

Events leading up to the franchise dispute

Our client, the Franchisor, owned a fast-food restaurant business. Our client franchised their business, granting use of:

  • Exclusive territory;
  • Trademarks;
  • Vehicle get up;
  • Customer relationship management system.

Managing the franchise dispute

The dispute concerned an ex-franchisee, Restaurant Ltd, who chose not to renew its franchise agreement. The franchise agreement contained restrictive covenants. These restricted Restaurant Ltd, after termination of the agreement:

  • From competing with our client’s business;
  • In the franchised terrritory;
  • For 6 months.

Restaurant Ltd opened a new fast-food restaurant business. It traded under a new name. It did not use the franchisor’s trademark or customer relationship management system. In addition, Restaurant Ltd rebranded its vehicles with the new name.

Our client wished to quickly stop Restaurant Ltd. Restaurant Ltd had breached the franchise agreement. It operated a fast-food business, in the same territory, within six months of terminating the franchise agreement. There was a clear breach of contract.

Restaurant Ltd, the franchisee’s defence

Restaurant Ltd argued that within the franchised territory:

  1. Our client no longer operated, because:
    • Our client had failed to franchise the territory to another business.
  2. Thus, no competing business could cause our client any loss,
    • Which included Restaurant Ltd.

Hence, Restaurant Ltd had not breached franchise agreement’s post-termination obligations. Restaurant Ltd should continue its business because there was:

  • No competing business within the territory; and
  • No unauthorised use of our client’s trademark.

Our client, the franchisor’s arguments

We argued the restrictive covenant protected our client’s goodwill in the territory. Customers visiting Restaurant Ltd would incorrectly assume it was still connected to our client. The 6 month period allows:

  • Customers to recognise a new proprietor;
  • Our client time to find a replacement franchisee.

The court’s decision

The judge agreed with us. The restrictive covenant’s fundamental purpose was to prevent Restaurant Ltd competing in the territory. This enabled our client to protect its goodwill.

The judge allowed the injunction. This stopped Restaurant Ltd operating a fast-food business in the territory for the remainder of the 6 months. Restaurant Ltd had agreed this provision when signing our client’s franchise agreement.

Conclusions

To build a successful business, franchisors must enforce their rights and control their franchising network.

Franchise disputes arise during and after the agreement. Drafting the franchise agreement to cover every eventuality is key.

What if franchisees do not perform as expected. Partially we avoid this risk by planning at the outset. If a franchisee’s performance cannot be improved, we’re skilled in resolving franchise disputes.  We also extract you from franchise agreements, with minimal exposure, and enforce your rights.

John Deane is a partner in the commercial team. Understanding the ins and outs of a franchising model is key to successfully resolving a franchise dispute. Please do get in touch with John if we can assist.