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Post-Contractual Restraint Clauses in Franchise Agreements: The Case of Narellan Franchise Pty Ltd v RBME Pty Ltd

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By Alicia Hill, Principal, and Darsh Chauhan, Law Clerk

Introduction

On 25 July 2022 Justice Richmond of the Supreme Court of New South Wales delivered judgment in the matter of Narellan Franchise Pty Ltd v RBME Pty Ltd.[1] This was a successful application for injunctive relief by a franchisor seeking to prevent representatives of a former franchisee from engaging in competitive conduct after the expiry of their commercial relationship with the franchisor.

Background

The Narellan Group (‘Narellan’) operated a swimming pool manufacturing, sales, and installation business which they developed into a franchise system in 2002. T&M Pools Pty Ltd (‘T&M Pools’) was one such franchisee which had operated two franchises in Sydney and of which Tim and Matthew were equal shareholders. In 2014 Tim and Matthew established two companies of which one was RBME Pty Ltd (‘RBME’), which, by the execution of two separate agreements, took over each of the franchises previously managed by T&M Pools. Tim and Matthew were guarantors under each agreement and were bound by its terms.

The agreements prescribed a geographical ‘territory’ within which the franchises were to operate (‘Territory Clause’). They also stipulated that for one year following expiry, RBME was prevented from:

  • carrying on a business similar to the franchise;
  • seeking to engage the patronage of clients whom it serviced under the franchise; and
  • marketing the products of the franchise within the locality defined by the Territory Clause. (collectively the ‘Restraints Clause’).

During the course of the operation of the franchises, Tim and Matthew sought to renew the term by which RMBE was contracted. Later, however, their relationship with Narellan deteriorated and they elected to cease their engagement with Narellan upon the expiry of the agreements.

After one of the franchise agreements expired on 30 April 2021, RBME continued to operate the franchise in accordance with a provision in the agreement which permitted it to manage the business by a licence to which Narellan consented and on a month-to-month basis. At this time RMBE had some 197 contracts on foot with customers which it desired to complete.

Issues

The issues in this interlocutory hearing were whether:

  • there was a serious question to be tried that the Restraints Clause was valid and enforceable against Tim and Michael with the result that they were precluded from operating a similar business, or in the alternative that it was invalid and unenforceable on the basis that it unduly restrained trade; and
  • whether the balance of convenience favoured the granting of the injunction to Narellan.

Decision

The Court found in favour of Narellan and awarded it injunctive relief on the basis that there was a serious question to be tried and that the Restraints Clause was valid and enforceable.

Reasons for Judgment

Justice Richmond commenced by restating the well-established legal principles concerning the award of injunctive relief that this matter was not a final determination of the whole of Narellan’s case (as there were other issues relevant to that assessment), but an evaluation of its ability to determine that there was a serious question to be tried.

His Honour proceeded by confirming that the Restraints Clause may be valid and not impermissibly prevent Tim and Michael from engaging in similar practices as when RMBE was in the franchise system if the circumstances of the case justified that it was ‘reasonably necessary for the protection of the parties concerned and reasonable in the interests of the public’.[2]

This was the effect of the doctrine of the restraint of trade at common law and also of the Restraint of Trade Act (1976) (NSW), which, in a broad way, demanded a balancing exercise of whether such a provision as the Restraints Clause would be contrary to public policy. The appropriate balance to be struck was between the protection of Narellan’s legitimate business interests and the economic detriment caused to the public by the anti-competitive impact of the Restraints Clause.

In this case, it was important to consider the effect of the Restraints Clause on the parties’ respective goodwill, which were distinguishable because of the ability of RBME to generate local goodwill independent of Narellan and to which Narellan had no interest or claim.

It was a legitimate commercial function of the Restraints Clause to prevent RMBE from exploiting that local goodwill in order to run a business in competition with Narellan after the expiry of the franchise agreements.

One interest which Narellan sought to protect was the connection with its customers. In the particular circumstances of the case, a ‘significant proportion’ of RMBE’s clients engaged its services as a result of ‘leads’ pursued by Narellan,[3] and many customers directed inquiries to Narellan rather than RMBE.

The Court therefore held that the goodwill in respect of the 197 contracts which remained afoot at the time of expiry belonged to Narellan and that damage would be incurred to that goodwill if the completion of those contracts was engaged in by Tim and Michael.

Another factor contemplated by Justice Richmond was that an ‘outgoing franchisee [Narellan] would have a competitive advantage over the incoming franchisee’.[4] That is because the new franchisee would be required to attend trainings and undertake similar introductory activities in connection with running the business of which RMBE, operating separately from the franchise system, could take advantage.

Indeed, this was the point of the temporal limitation of one year on the Restraints Clause — it was destined to allow for the new franchisee to become acquainted with the business after which time the restraints on Tim and Michael would cease to apply, rather than merely to prevent Tim and Michael from engaging in a competitive business.

Finally, on the second issue concerning where the balance of convenience lay, the Court exercised its discretion in favour of Narellan. This was because:

  • Tim and Michael were only prevented from operating competitive businesses within each Territory, and not outside of those areas;
  • Tim and Michael were aware that the Restraints Clause would be enforced against them by Narellan and could have earlier established a plan for their conduct for the year during which the Restraints Clause operated;
  • Narellan had not delayed in bringing the proceedings; and
  • as to whether an injunction would unduly burden any third party, Justice Richmond held that the scope of the relief to be granted should exclude all conduct to be taken to complete the contracts which remained afoot.

Ultimately, the Court determined that Narellan should be granted injunctive relief because the Restraints Clause did not unfairly restrain Tim and Michael from engaging in business activity, but that those restraints were reasonably necessary to protect its legitimate interests.

Takeaways

This case provides an example of circumstances where a clause purporting to restrain the activities of a franchisee following the expiry of the term of its agreement with a franchisor was valid and enforceable.

In particular, both franchisors and franchisees should be wary of the distinction between which of them is the proper owner of goodwill. To do so requires a thorough and ongoing examination of the nature of the commercial reality in which the franchise agreement operates.

Franchisors should take special care to ensure that post-contractual restraints have a legitimate function, and franchisees should take note that it is not a simple matter to exploit the benefit of their time as a franchisee under the umbrella of a franchise system if they eventually exit from the franchise system.

If you have any questions regarding this decision or any matters raised by it, please feel free to get in contact with Alicia Hill of the MST Dispute Resolution and Litigation team on (03) 8540 0200, or by email at alicia.hill@mst.com.au.

[1] [2022] NSWSC 988 (‘Narellan’).

[2] Narellan (n 1) [47], quoting Isaac v Dargan Financial Pty Ltd (2018) 98 NSWLR 343, 355 [59] (Gleeson JA, Bathurst CJ agreeing at 345 [1], Beazley P agreeing at 345 [2]), citing Nordenfelt v The Maxim Nordenfelt Guns and Ammunition Company Ltd [1894] AC 535, 565 (Lord Macnaghten); Lindner v Murdock’s Garage (1950) 83 CLR 628, 633 (Latham CJ); Buckley v Tutty (1971) 125 CLR 353, 376, 379–80 (Barwick CJ, McTiernan, Windeyer, Owen and Gibbs JJ).

[3] Narellan (n 1) [73].

[4] Ibid [76].