Post-termination restrictive covenants in franchising agreements may not be as enforceable as once thought after the outcome of a recent court of appeal case.
Franchisors should consider the impact of this judgment and review their existing agreements to consider ways in which any covenants can be tailored to ensure that they are ‘reasonable’.
Post-termination restrictive covenants case
On 30 June 2022 the Court of Appeal laid down its judgment in Dwyer (UK Franchising) Ltd v Fredbar Ltd and Shaun Bartlett [2022] EWCA Civ 889 in which they dismissed Dwyer’s appeal against an earlier High Court decision which ruled that the post-termination restrictive covenants in its franchise agreement were unenforceable.
This ruling is of crucial importance for franchisors using standard form agreements with its franchisees, but particularly so where the franchisee is an inexperienced individual. The judgment has dismissed the widely-held belief that a twelve-month restrictive covenant will generally be enforceable upon a franchisee provided that the restricted activities and geographic area covered were suitably limited. Franchisors would be well-advised to review their current agreements in light of this; each clause should be considered on a case-by-case basis.
Background to the case
The claim was brought by Dwyer, franchisor of ‘Drain Doctor’, against its franchisee, Fredbar Ltd, and Mr Bartlett, who was the sole director and shareholder of and guarantor for Fredbar Ltd. Mr Bartlett had no previous experience of plumbing or drainage, or of being a company director. The business had been operating for eighteen months of the ten-year franchise agreement under the Drain Doctor name prior to termination by Fredbar.
The agreement contained a twelve-month post-termination restriction which prevented the franchisee from being engaged in a business similar to or competitive with Drain Doctor within either:
- the territory for which the franchisee had been granted exclusivity; or
- a radius of five miles from it.
‘Inequality of arms’
The judge put great stock in the inequality of bargaining power between the parties. Dwyer is the largest emergency plumbing and drainage company in the country. Bartlett was, essentially, a ‘man with a [hired] van’. He invested all his savings in the business and borrowed money against his home from the bank to pay the initial franchise fee and had no prior experience either in plumbing or of running a franchise. The nail in the coffin was that the standard form agreement had to be accepted or rejected; there was no evidence of discussion or negotiation of the restraint of trade provision.
The factors above meant that the judge considered the franchise agreement to be more similar to an employment contract than to the sale of a business. Accordingly, the courts thought the restrictions to be excessive as they effectively prevented Bartlett from continuing to act as a plumber where he lived.
Lack of goodwill
One of the other major themes in the case was whether Dwyer had any goodwill to protect in the territory. Restrictive covenants can only be relied upon where they are:
(i) necessary to protect a legitimate interest; and
(ii) extend no further than is reasonably necessary to do so.
Dwyer argued that protecting their goodwill within the territory was a legitimate interest that needed to be protected.
The judge disagreed and in fact found that there was no goodwill at all in the territory. There had been no prior franchisee in the territory and no other franchise nearby; it was not a ‘ready-made’ business. The franchisee’s earnings were limited and far below projections. Moreover, the franchisee had only been operating for eighteen months prior to termination of the franchise and four of those were during the pandemic. The twelve-month restriction that Dwyer argued was necessary to give a new franchisee a ‘clear run’ was therefore deemed to be unreasonable.
Appeal dismissed
The Court of Appeal judge agreed with the findings of the High Court: the restrictions were unreasonable and hence unenforceable. They would prevent Bartlett from engaging in any plumbing or drainage business within the territory. In particular, it was reasonably foreseeable by the franchisor that, when the contract was entered into, the application of the first restriction would seriously increase the risk of Bartlett being unemployed and facing mortgagee possession proceedings. The second restriction was also applied to an unreasonable radius.
What can franchisors do?
The ruling emphasised that restrictions will be assessed on the facts of each case. The twelve-month restrictions will not be unreasonable in every case, nor in every Drain Doctor franchise agreement.
Review your franchise agreements
Franchisors should now review any post-termination restrictive covenants in their agreements. The judgment in this case emphasised that there is no ‘one size which fits all’, so these should also be reviewed in light of each franchisee.
It would be useful for all franchisors to consider:
- requiring the franchisee to seek independent legal advice, particularly where there is an inequality of bargaining power;
- offering variable franchising fees depending on whether a post-termination restrictive covenant is included;
- whether you already have goodwill in the area to protect and measure this against the length and radius of covenant that might be reasonable;
- including a provision stating that the restriction may be overridden with the franchisor’s written consent;
- providing for different periods of restriction depending upon the length of the franchise agreement;
- limiting the covenants to involvement in a competing business rather than a similar business;
- generally, ensuring that the restrictions are as narrow as possible;
- making clear that the non-compete covenants do not apply if the agreement is terminated for the franchisor’s breach;
- ensure that you include a non-solicitation clause as well as a non-compete clause to facilitate the ‘blue pencil test’ whereby, if the non-compete is deemed unenforceable, the non-solicitation clause could still be upheld as these are generally more enforceable; and
- discussing with your solicitor any other ways in which the covenants could be made reasonable.
Our team of franchise experts can help you review your post-termination restrictive covenants. Visit our Franchising page to see the services we provide for franchisors.
A version of this blog was first published in New Law Journal. A pdf of the published article can be found below.