How Can Franchisors Draft Restraint of Trade Clauses That Are More Likely to Be Upheld by Australian Courts?

In Short

• Restraint of trade clauses stop former franchisees from competing unfairly by using the franchisor’s systems, brand or confidential information.
• Courts will only enforce restraints that are reasonable in scope, area and duration, and genuinely protect legitimate business interests.
• Restraints must also comply with the Franchising Code, particularly where renewal rights and goodwill compensation apply.

Tips for Businesses

When drafting restraint of trade clauses, ensure the restricted area and timeframe reflect the actual reach of your business. Avoid overly broad terms, as unreasonable restraints are unlikely to be enforced. Review the franchisee’s background and the circumstances of any non-renewal to ensure the restraint is appropriate and compliant with the Franchising Code.

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Table of Contents

• What is a Restraint of Trade Clause?
• Structure of Restraints (Geographical Limitation and Time Limitation)
• Reasonable Scope and Protecting Legitimate Business Interests
• Section 42 of the Franchising Code of Conduct
• Implications of Unreasonable Restraint of Trade Clauses
• Key Takeaways
• Frequently Asked Questions

In the dynamic world of franchising, crafting legally robust agreements is paramount for safeguarding the interests of both franchisors and franchisees. A central component of these agreements often involves the use of restraint of trade clauses. These clauses protect the franchisor from unfair competition by former franchisees. They prevent former franchisees from using the franchise’s business model, trade secrets, or clientele for competitive advantage. Drafting these clauses is challenging because Australian courts assess them for reasonableness and fairness. This article outlines how to draft enforceable restraint of trade clauses that comply with the Franchising Code.

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What is a Restraint of Trade Clause?

Restraint of trade clauses limit a franchisee’s commercial activities after their relationship with the franchisor ends. These clauses protect the franchisor’s intellectual property, brand reputation, and competitive position within the market. Typically, these clauses restrain former franchisees from establishing or joining competing businesses in specific areas and for defined periods. The underlying premise is to prevent new market entrants from capitalising unethically on the franchisor’s business systems and confidential information. Australian courts require restraints to be reasonable, placing the responsibility on franchisors to draft enforceable terms.

Structure of Restraints (Geographical Limitation and Time Limitation)

In drafting effective restraint of trade clauses, two critical dimensions require careful attention: geographical and temporal restraints.

Geographical limitations define the physical areas in which former franchisees are prohibited from engaging in certain business activities. The restraint area may range from the local franchise vicinity to broader regions, depending on the franchisor’s business interests. Courts are more likely to uphold geographical restraints that reflect the franchise’s actual operating area. They are less likely to uphold restraints that extend into markets where the franchisor has no competitive presence.

Time limitations specify the duration of the restraint after termination of the franchise agreement. While longer durations may seem more protective, the key is proportionality. Courts generally view restraint periods of six to twelve months as reasonable unless a longer duration is clearly justified. A longer restraint may be justified if the franchise operates seasonally and requires protection across the whole business cycle.

Reasonable Scope and Protecting Legitimate Business Interests

Restraint clauses must extend only as far as necessary to protect the franchisor’s legitimate business interests. These interests can include protecting trade secrets, confidential information, and the goodwill associated with the franchise brand.

Restraint of trade clauses must go no further than necessary to protect the franchisor’s legitimate business interests. If a franchisee already has substantial industry experience, the restraint should be less restrictive. Courts are unlikely to uphold restraints that unfairly limit the franchisee’s professional mobility.

Section 42 of the Franchising Code of Conduct

The statutory framework provided by the Franchising Code of Conduct imposes additional considerations for restraint of trade clauses. Section 42 prohibits franchisors from including restraint of trade clauses that would apply where all of the following conditions are met:

• the franchise agreement expired and contained an option for renewal or extension;
• before expiry, the franchisee gave written notice seeking renewal on substantially the same terms as the franchisor’s current agreements or those offered to other franchisees;
• the franchisee met all required conditions for renewal;
• Immediately before expiry, the franchisee was not in serious breach and had not infringed intellectual property or confidentiality obligations during the agreement term;
• the franchisor refused to renew, and the franchisee claimed compensation for goodwill; and
• either the compensation was nominal/inadequate, or the agreement did not provide for goodwill compensation on non-renewal.

Importantly, this provision only renders restraint clauses unenforceable in these narrow circumstances. Section 42 does not apply if the franchisee breaches confidentiality, has no renewal option, or receives goodwill compensation.

Implications of Unreasonable Restraint of Trade Clauses

If a restraint clause is unreasonable, the court will not enforce it, leaving the franchisor without recourse. Courts may choose to sever or modify excessively broad terms to uphold only the reasonable aspects of the clause, although this is not guaranteed. An unenforceable clause risks allowing the former franchisee to utilise proprietary knowledge in competing ventures, which could negatively impact the franchisor’s business. Consequently, it is crucial for franchisors to carefully draft these clauses to balance their business interests with the rights of the franchisee, reducing the risk of litigation and ensuring legal protection.

Key Takeaways

Restraint of trade clauses are crucial yet complex components of franchise agreements, demanding a meticulous approach to ensure enforceability. By aligning these clauses with the principle of reasonableness —tailoring geographical and temporal limitations, considering the individual background of franchisees, and aligning contractual provisions with the Franchising Code of Conduct, franchisors can enhance the prospect of their clauses being upheld in court. Understanding and respecting the balance between protection and fairness will ultimately support sustainable franchise relationships and uphold the integrity of the franchising sector.

If you need assistance in navigating restraint of trade clauses in your franchise agreements, our experienced franchise lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions