The enforceability of post termination non-compete clauses in franchise agreements has long been the subject of judicial scrutiny and remains a source of some uncertainty for franchisors and franchisees alike. Finding the balance between protecting a franchisor and its franchised network’s interests and restricting an individual’s ability to earn a livelihood can be difficult. Get it wrong and a departing franchisee could be free to compete immediately.
Another fairly standard contract term that contracting parties have had to pay special attention to recently is force majeure clauses. At the outset of the pandemic, there was much debate as to whether COVID-19 could constitute a force majeure event and in what circumstances parties should exercise their discretion to suspend performance.
In the recent case of Dwyer (UK Franchising) Ltd v Fredbar Ltd & Anor [2021] EWHC 1218, the High Court was tasked with first deciding whether an enforced period of self-isolation was sufficient to trigger a force majeure clause in a franchise agreement and thereafter, with assessing the reasonableness of the post termination non-compete restrictions imposed upon the franchisee. The case also gave the court a chance to address several other matters that are of general interest to the franchise industry.
Background
The claim was brought by the UK franchisor of the Drain Doctor concept, a plumbing and drainage business, against its franchisee (the first defendant) Fredbar Ltd (who had become a Drain Doctor franchisee in October 2018) and Mr Bartlett (the second defendant) acting as guarantor for Fredbar Ltd.
In March 2020, shortly after the impact of the COVID-19 pandemic was beginning to be felt in the UK, Mr Bartlett received notification from the NHS that his young son was deemed “vulnerable” and would be best to stay home for the next 12 weeks to avoid the virus. Mr Bartlett emailed the franchisor initially to advise there had been a drop in demand and enquire whether the franchise agreement could be suspended under its force majeure provisions. He emailed again a few days later, again requesting suspension of the agreement on the grounds that he had to self-isolate to care for his young son. The franchisor refused both requests noting that plumbers were classed as key workers and that fewer jobs did not constitute a force majeure event. It disputed that the force majeure clause in the agreement applied.
In April, the franchisor offered to allow Mr Bartlett to take furlough, which he did. Later that month however, he confirmed that out of “fear for income” and of “having to pay more than £20,000 for breach of agreement”, he had continued to trade. On 16 July, Mr Bartlett purported to terminate the agreement for, amongst other things, breach of the force majeure clause by the franchisor.
The franchisor asserted that Mr Bartlett’s failure to be bound by the franchise agreement constituted a repudiatory breach and on that basis terminated the agreement, issuing a claim for damages against the defendants and additionally seeking injunctive relief to prevent Mr Bartlett breaching the non-compete covenants contained within the franchise agreement. In May this year, the High Court handed down judgment.
High Court decision
In determining whether the franchisee was entitled to terminate in July 2020 and how matters should proceed thereafter, the court had to consider several aspects of the franchise relationship, namely:
- Whether the franchisor’s refusal to exercise its discretion under the force majeure clause was a breach of the agreement
- Whether the franchisor had been guilty of misrepresentation in the first place capable of inducing the defendants to enter the network and acquire the franchise
- Whether the franchisor had misused a marketing and promotion fund
Once a conclusion had been reached on that, it was then for the court to decide whether the post-termination non-compete restrictions within the franchise agreement could be enforced if applicable.
- Force Majeure
Clause 30 of the franchise agreement was drafted as follows:
“This Agreement will be suspended during any period that either of the parties is prevented or hindered from complying with their respective obligations under any part of this Agreement by any cause which the Franchisor designates as force majeure including strikes, disruption to the supply chain, political unrest, financial distress, terrorism, fuel shortages, war, civil disorder, and natural disasters.”
In deciding whether the franchisor had committed a breach of the agreement by failing to treat Mr Bartlett’s self-isolation as a force majeure event, the court considered the principles from the landmark case of Braganza v BP Shipping Ltd [2015] WLR(D) 158, which imposed upon decision-makers a duty to exercise their discretion “reasonably” or “rationally” and not “arbitrarily, capriciously, perversely or irrationally”.
The court held that, by failing to take account of the fact that Mr Bartlett had been forced to self-isolate for 12 weeks to protect his son’s health, the franchisor had not considered all relevant matters when reaching its decision on whether clause 30 applied. Accordingly, it was held that the franchisor had breached the Braganza duty and, as the force majeure was a fundamental term, had thus committed a repudiatory breach of the franchise agreement.
- Misrepresentation – profit projections
During contractual negotiations, various franchise figures were provided to Mr Bartlett. These figures contained financial projections for the potential performance of franchisees. Mr Bartlett claimed that he had relied upon these figures when deciding whether to enter into the franchise agreement and alleged that they were misleading and inflated, something which the franchisor denied.
Starting from the position that projections were not a guarantee of performance, the Judge found the projections were based upon average data, rather than data specific to the franchise area in question, something that Mr Bartlett knew to be the case. He noted that the defendants had not presented any evidence as to why the projections were negligent and observed that Mr Bartlett was “perfectly entitled” to investigate the local market and consider other factors when deciding whether to rely upon the projections.
On that basis, it was held that the franchisor had reasonable grounds for presenting the projections as a forecast and no misrepresentation had taken place.
- Misuse of MAP fund
Finally the court considered the franchisor’s use of a marketing and promotion (MAP) fund to which franchisees made regular contractual contributions.
Clause 11 of the agreement provided that the MAP fee must “only” be used to establish a marketing advertising and promotion fund and to use that fund "upon such national advertising and/or promotional activities as the Franchisor thinks fit, including establishing and maintaining a relationship, with Key Accounts Customers…".
On 24 January 2020, the franchisor notified franchisees that the National Account administration charge would increase from £2.50 per job to £12.50. The reason for the increase was explained as follows: “Currently the cost of administering the National Account team sits within the MAP fund and therefore the fund is not being used in the appropriate way and leaves no funds to undertake much needed national promotional activity. By implementing the correct fee, we will be able to release the burden on the MAP fund and allow the National Accounts function to support itself. The MAP fund can then be used for its intended purpose, which will benefit the whole Network."
The court set out, in no uncertain terms, that the MAP Fund should not be used to subsidise the National Account team, noting that it was not a trust, nor was it the franchisor’s asset. It held that the franchisor’s use in that regard was a repudiatory breach of the agreement.
Final judgment and assessment of restrictive covenants
Despite finding in favour of the defendants on the force majeure and MAP Fund issues, the court held that the defendants were not entitled to terminate the agreement in July 2020. Mr Bartlett was deemed to have affirmed the agreement on both occasions: in the case of the force majeure breach, by accepting the offer of furlough and with regards to the MAP fund, by not attempting to terminate at the point he was informed of the breach, namely when he received the 24 January 2020 email.
Accordingly, the agreement was held to have been effective when Mr Bartlett purported to terminate in July 2020 and, in doing so, he was found to have committed a repudiatory breach himself, allowing the franchisor to terminate instead.
Having established that the claimant was entitled to terminate the franchise relationship, the court was asked to consider the enforceability of the post-termination non-compete restrictions within it.
On the face of it, such provisions are contrary to public policy, restricting, as they do, individuals’ ability to work within a certain area for a certain period of time once the franchise relationship has come to an end. In the UK, the Competition Act 1998 (the Act) expressly prohibits all agreements between businesses that restrict competition, unless they meet the stated conditions for exemption.
In that regard, for a post termination non-compete clause to be enforceable, the franchisor must have a legitimate business interest to protect and the covenants must only go as far as is reasonably required to protect a franchisor’s intellectual property and business interests, in terms of duration and geographical scope. European case law has upheld a covenant that lasts for up to 12 months from termination but any more than this and the covenant is likely to be open to challenge.
The Drain Doctor franchise agreement that Mr Bartlett had signed prohibited him from, for a period of one year after expiration or termination of the franchise agreement being “engaged concerned or interested in a business similar to or competitive with the Drain Doctor Business” both “within the Exclusive Marketing Territory” and “within a radius of five miles from the Exclusive Marketing Territory”.
The court held that this was unreasonable and unenforceable. The term “Drain Doctor Business” had not been defined in the agreement so was taken interpreted by the court as referring to the business of plumbing and drains. The first restriction therefore prevented Mr Bartlett from engaging in any plumbing or drainage business whatsoever within the Cardiff area (even where his activity would not affect the franchisor’s goodwill) and was held to seriously increase the risk of unemployment for Mr Bartlett, potentially causing repossession of his family home. The second restriction extended the restraint of trade by an unnecessary range, to an area the claimant had no goodwill to protect.
The court held that the restrictions failed to strike “a reasonable balance between the freedom of contract and the freedom of trade”, and “were far more extensive than was required to provide reasonable protection”. Mr Bartlett’s lack of experience both in the industry and as a director of a company was a contributing factor.
Comment
Whilst the case is obviously fact-specific it raises a number of important issues that franchisors should consider, both at the drafting stage and during the course of the franchise relationship.
Given the uncertain times we live in, parties should always be mindful of the Braganza duty when it comes to exercising discretion on matters like force majeure events and ensure that they do so honestly and in good faith, taking all relevant matters into account.
Where funds are put in place for specific purposes, franchisors must only attribute the sums collected from franchisees for that purpose, even if they have a justifiable reason to divert the income to other parts of the business.
Finally, franchisors must take care when drafting the post-termination restrictions they intend to impose on departing franchisees, both in terms of properly defining the scope of the business they aim to protect and in striking a reasonable balance between protecting that business and not unfairly restraining the franchisee’s ability to earn a living going forward. Fail in either respect and the restrictions are likely to be struck out as unenforceable.
Nicola Broadhurst