If you’re a franchisee, and thinking about leaving the franchise, it’s important to note that there are restrictions on what you can do next. These restrictions are typically in the form of a restraint. You may have questions about whether you can:

  • continue to operate your business without the franchise name;
  • start a new business in the same industry; or
  • relocate to another area and start a similar business?

The answer will vary based on the franchise, the wording of the restraint in the franchise agreement, and any negotiated agreement. This article looks at the relevant factors to consider when answering these questions upon exiting a franchise.

Effect of Restraints in a Franchise Agreement

Nearly every franchise agreement will include a restraint of trade clause, sometimes called a restrictive covenant or non-compete. The purpose of these clauses is to forbid a franchisee from operating in competition with the franchise system. A restraint clause prevents a franchisee from operating a similar business during and after the term of the franchise agreement. A franchise agreement may also include a non-solicitation clause. Such clause seeks to stop a franchisee from soliciting any current or former employees and customers without the franchisor’s consent.

However, only reasonable restraint of trade clauses are enforceable.  Unreasonable clauses are void. To demonstrate that a restraint is reasonable, a franchisor has to take a franchisee to court. Generally, courts first examine whether the franchisor has a legitimate interest that warrants the restraint.  For example, a court may look at the area the restraint covers. If the franchise only operates in one state, but the restraint geographically extends to all of Australia, the court will likely reject the restraint.

The court can also reconstruct the scope of the restraint so that it becomes reasonable. For example, a court can change the Australia-wide restraint to only prevent operation of a similar business in the state of the franchisor. Due to this, it is best to draft a restraint clause to provide a court with options for what may be considered reasonable. Essentially, this allows a court to pick and choose which combination of options should apply.

Negotiated Arrangements with the Franchisor

A franchisee can still negotiate a release even if the franchise agreement has a reasonable restraint clause. If you do this, document the results of this negotiation in a formal settlement agreement. Even when a franchisor expresses that it will not prevent a franchisee from operating outside the system,  a formal agreement ensures that the franchisor cannot bring a claim for breach of the restraint.

This settlement arrangement is usually set out in a deed of settlement and release—a contract that finalises the relationship between the franchisor and franchisee. These settlements often occur when parties decide to disassociate themselves from one another for various reasons. For example, it may no longer be in the interests of both parties for the franchisee to remain under the branding of the franchisor. Sometimes such disassociation may occur before the end of the fixed term. In such case, a deed of settlement releases the parties from liability for any possible breaches of their obligations.

Additionally, a franchisor can contractually agree to release the franchisee from any restraint. However, a franchisor is not normally obliged to enter into a settlement agreement with a franchisee. They may be reluctant to release a franchise from a restraint clause. Doing so risks the ex-franchisee becoming a competitor with skills and experience from their franchise network.

Alternatively, the franchisor may enter a settlement agreement to ensure that they do not have any future liability. For example, if the franchisor fails to comply with terms of the franchise agreement, entering into a settlement agreement may prevent the franchisee from taking legal action. Negotiations between parties typically result in settling. Such negotiation is without prejudice, where both franchisor and franchisee can speak openly about their intentions for the future and willingness to compromise. Once both parties come to an agreement, one side drafts a deed and the other side reviews it.

Key Takeaways

Most franchise agreements contain restraints of trade or restrictive covenants. These restraints will not automatically apply. Rather, they are unenforceable unless there is a reasonable requirement to protect the legitimate interests of the franchisor. However, a franchisor can take action to enforce a reasonable restraint. This can affect a franchisee’s ability to operate a similar business after leaving the franchise.

If you’re a franchisee looking to continue operating after you leave a franchise, LegalVision’s franchise lawyers can advise you on your rights. Call us on 1300 544 755 or fill out the form on this page.

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