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EzyDVD v Lahrs: Restraints of trade in franchising

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The restraints of trade  found in franchise agreements generally seek to prevent the franchisee, both during and after the term of the franchise agreement, from engaging in a business that competes with the franchised business for a certain period of time and/or from soliciting customers or employees of the franchise system for a period of time.  Such restraints are also normally limited to a geographical area.

As a general rule, provisions in contracts which constitute unreasonable restraints of trade are void on public policy grounds as they restrict competition in the marketplace and a person’s right to derive income.  However, traditionally this general rule has not been rigidly applied in a franchisor/franchisee relationship because most franchise agreements contain a restraint which is limited in scope.

Previous court cases on the subject have taught us that contractual restraints will only be enforceable if, and to the extent that, they are considered reasonable, after giving due regard to the competing interests of the franchisor, the franchisee and the general public.

Judgements have also commented that a restraint cannot go beyond what is reasonably necessary to protect the legitimate business interests of the franchisor.  Interestingly, in assessing the franchisor’s relevant legitimate business interests, the courts look at those which existed at the time the franchise agreement was entered into, rather than the franchisor’s interests at the time the restraint is sought to be enforced.

Courts have identified specific legitimate business interests which a franchisor may seek to protect by enforcing a restraint of trade clause.

However, the recent decision of the Supreme Court of Queensland in the case of EzyDVD Pty Ltd v Lahrs Investments Qld Pty Ltd has cast some doubt over developed in previous cases.

In this case, the franchise agreement was terminated after the franchise had operated for a year and a half.  Following termination, the franchisee, using a different corporate entity, immediately commenced operating a similar business from the same premises.

The franchisor sought to enforce the restraint clauses in the franchise agreement, which provided that the franchisee would be restrained from operating a similar business for 6 months after the termination of the agreement within a radius of 5km from the franchise business premises and 1km from any other EzyDVD store in Australia.

The restraint provisions identified that the purpose of the restraint was to protect the confidential information and intellectual property provided by the franchisor to the franchisee during the course of the franchised business.

However, elsewhere in the franchise agreement there were obligations imposed upon the franchisee for the purposes of protecting the franchisor’s confidential information and intellectual property.  These provisions governed the manner in which the franchisee could use the confidential information and intellectual property and required the franchisee to return or destroy all copies of the same in its possession upon termination of the franchise agreement.

The franchisee had complied with the provisions in the franchise agreement relating to protecting the franchisor’s confidential information and intellectual property.

Because the franchisor’s case was premised on the argument that the restraint was reasonably necessary to protect the franchisor’s confidential information and intellectual property, the Court found that it was not reasonable for the franchisor to enforce the restraint in addition to the contractual procedure designed to ensure the same protection.

As a result of this decision, it appears that where a franchise agreement contains other clauses which can be relied on to protect the franchisor’s confidential information and intellectual property, any restraint intended to protect the same may not be reasonable and therefore rendered unenforceable.  The decision may have differed if the restraint provision referred to other considerations, such as protection of the franchisor’s goodwill or customer database.

This case highlights that franchisors must draft restraint provisions carefully and with due regard to the intended purpose of such clauses and the interests the franchisor is wanting to protect.  In addition, when seeking to enforce a restraint, it is vital that the franchisor clearly articulates the interests it is attempting to protect.

If you have questions regarding franchising restraints contact one of our Franchising lawyers.

Author:  Esther Gutnick