Back In Motion undertakes not to enforce unfair restraints and exit fees | Does this mean it’s back to the drawing board for franchisors in Australia?

By Louise Wolf, Senior Associate, MST Lawyers

It is not uncommon to find clauses in franchise agreements which restrict certain business activities of franchisees after the term of a franchise agreement has come to an end.  These are often called post-term restraints.  Such clauses may seek to impose restrictions on a former franchisee conducting a competing business or from poaching clients or staff from the franchisor or other franchisees in the network.

There have been many cases that deal with the enforceability of such post-term restraints and the law is quite settled.  The Franchising Code of Conduct also contains provisions that affect a franchisor’s right to enforce a post-term restraint if certain circumstances exist.  In addition, the unfair contract terms provisions of the Australian Consumer Law could impact on the enforceability of post-term restraints.

The ACCC, which oversees these laws, has been active in taking action in cases where post-term restraints or exit fees (i.e. a fee payable to be released from a post-term restraint) are considered unfair.  Recently the ACCC accepted a court-enforceable undertaking from Back In Motion Physiotherapy Pty Ltd (Back In Motion) that has cut through their restraint clauses and struck down their exit fee. 

The ACCC had concerns that the restraint clauses in the Back In Motion franchise agreement were unfair.  The restraint clause provided that franchisees must not provide physiotherapy services within a business that competed with Back In Motion, within the ‘restraint area’ during the ‘restraint period’.  The cascading nature of the restraint clause meant that the restraint could be as extensive as a 10 km from any Back In Motion site in Australia for 12 months, to as little as the former franchisee’s site for 3 months.  Given the number of Back In Motion sites, at its broadest, the restraint would prevent franchisees from providing physiotherapy services in most metropolitan areas of Australia for 12 months after the end of their franchise agreement, including in locations in which their former clients did not reside.   The ACCC believed this unfairly prevented the franchisees from practising physiotherapy, being a field in which they had studied and achieved qualifications and gained experience. 

It was not just the breadth, but the inherent uncertainty of the cascading clause (which contained 21 possible combinations of restraint) that was a factor contributing to the ACCC’s concerns about unfairness.   

In addition, the franchise agreement provided that franchisees who left the system before the end of the term could ‘buy’ their way out of the restraint by paying a buy-out fee.  The buy-out fee equated to four times a franchisee’s annual royalties. 

As a consequence of the ACCC’s concerns, Back In Motion has given an undertaking not to enforce the restraint of trade and buy-out fee clauses in existing franchise agreements and franchise agreements that ended 12 months before the date of the undertaking and has further agreed not to include similar clauses in future franchise agreements.

As part of the undertaking Back In Motion is also required to write to every existing franchisee and former franchisee who has exited in the preceding 12 months to notify them of the undertaking. 

Back In Motion is permitted to rely on a clause that restrains former franchisees for a period of up to 9 months after the end of their franchise agreement from actively soliciting a client located within 10 km of the former franchisee’s premises, where the former franchisee knows they were a client of a Back In Motion franchisee in the last 12 months of the franchise agreement.

This enforceable undertaking may be seen as a win for the ACCC and for affected Back In Motion franchisees. 

But it is not a Court ruling nor does it create any binding precedent.  That said, it cannot be ignored by franchisors, because it clearly sets out the ACCC’s views as to such clauses.  It appears that the ACCC has concerns about cascading clauses themselves. 

Cascading restraints (usually in relation to the duration of the restraint and its geographic reach) have been used by the drafters of franchise agreements to increase the chances of them being enforced by Courts.  Courts have traditionally read down cascading restraints to a point where they are reasonable and enforceable. 

But there have been no cases to date where such types of clauses have been considered in the context of the unfair contract terms provisions in the Australian Consumer Law.  One day a Court may have to decide whether cascading restraints are unfair and liable to be declared void or unenforceable.  It is certainly difficult for a franchisee to understand the duration and breadth of a cascading post-term restraint and it might be argued that this, in itself, makes the clause unfair.

The position taken by the ACCC raises some interesting questions:

• Is any restraint clause that has the potential consequence of preventing former franchisees from operating in large areas of metropolitan cities in danger of being held to be unfair and unenforceable?
• Is it possible that courts might distinguish this case as being different because physiotherapists spend years training before becoming qualified? But then, should someone who makes sandwiches be treated differently? 
• Will the additional factor of the excessive buy-out fee be a distinguishing factor?
• The ACCC has proposed that unfair contract terms be illegal. If this occurs, will cascading restraint clauses (even those that are only partially unenforceable) expose franchisors to risk of pecuniary penalties? 
• Should franchisors significantly narrow their cascading restraint clauses to avoid unenforceability and/or possible future penalties?

One thing is certain, franchisors need to review the restraint clauses in their franchise agreements and be satisfied that, if challenged, they can mount a strong argument that the clause does not go beyond what is required to protect the legitimate business interests  of the franchisor.

For advice regarding how these changes might affect your franchise, please email the Franchising Team at MST Lawyers.