New Zealand Law Society - Further developments in franchising restraint of trade clauses

Further developments in franchising restraint of trade clauses

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After a hiatus in the number of decisions dealing with the issue of enforceability of restraint of trade clauses in franchising, there have now been two in quick succession. The decisions had opposite outcomes for the franchisees.

Both franchise systems involved are substantial New Zealand franchise systems, having been in operation for many years.

I reported on the first of these two decisions, MadButcher Holdings Ltd v Standard 730 Ltd [2019] NZHC 589 in LawTalk 928, May 2019, pages 37-39. In that decision, the franchisee, whose franchise agreement had come to an end due to effluxion of time, was injuncted from trading in a competitive business on an interim basis. The franchisee sought to argue that there was a serious question to be tried that the franchisor had no intention of re-establishing itself in the territory. Gault J acknowledged there was some force in the franchisee’s argument that the restraint could be unreasonable if the franchisor had no intention of competing for continuing business in the region, however he noted that the restraint was to be scrutinised as at the date of the agreement, not according to subsequent events. The decision went against the franchisee.

At the end of May, a second decision of the High Court was released, Mainland Digital Marketing Ltd v Willetts [2019] NZHC 1201. The decision concerned the Open2view franchise system. This is a business that will be familiar to almost anyone who has ever sold a property and has had to use the services of a professional photographer. Franchisees in the system provide photography services to real estate agents and anyone else selling property to assist in the marketing of properties. Like any service provider, franchisees will obviously build up relationships with particular agents.

The background was that the franchisee entered into the relevant sub-franchise agreement in 2014. Pursuant to that agreement, there was the usual grant of the right to operate the franchise business for a particular term, within a particular territory and with the ability for the franchisee to use the franchise system including all intellectual property and confidential information in the operation of the franchise business.

The franchisee was authorised to provide photography services to a maximum of 100 agents from certain identified real estate businesses. That initial list included Bayleys Rural and came to include Bayleys' offices in Christchurch.

Over time, Bayleys became the franchisor’s biggest client.

The restraint of trade clause

The relevant restraint of trade clause provided that the franchisee:

“…would not from termination date conduct on their own or other account or be connected or interested either directly or indirectly as owners, partners, directors, officers, consultants, representatives, agents, licensees, investors with or as part of any business, firm or corporation which could be regarded as a market competitor or an imitation of the franchise system, including without limiting the generality of this clause any business identical with or similar to the franchised business or the restraint business and the [franchisee] shall contemporaneously with completion of this agreement complete the restraint agreement…” (emphasis added).

Issues arose between the respondents and the franchisor. In February 2019, the respondents began discussing with the franchisor the possibility they would not renew their franchise agreements. On 22 March 2019 the respondents advised the franchisor in writing that they would not be continuing with the franchise business.

Traditional Bungalow

Following discussions and negotiations between the respondents and Bayleys, Bayleys then employed the respondents by way of employment agreements dated 26 March 2019.

A key question was, as employees of a sizeable client of the franchisor, were the franchisees arguably in breach of the restraint of trade obligation not to be associated with a market competitor or an imitation of the franchise system.

It would not be unusual to see a restraint of trade clause in a franchise agreement which limited the nature of the restricted activity to just activity which was directly competitive with the franchisor. This is because the primary concern of franchisors is the need to protect their legitimate interest by preventing an ex-franchisee from rebranding and continuing to trade on as before, effectively using all of the intellectual property and systems that they have learned during their time as franchisees to now compete with the franchise system.

That said, the need to prevent franchisees from working generally in the same field of activity as the franchisor, whether competitive or not, does arise from time to time, for instance where ex-franchisees seek and obtain employment from other franchisees in the system. In certain franchise systems, where this practice occurs, typically the restraint clause would be sufficiently widely worded to encompass that form of activity.

The parties’ views

In the Open2view case, the respondents submitted that the restraint provision was simply not drafted widely enough to encompass the franchisee’s activities.

On the flipside, it was argued for the franchisor that to restrict the effect of the restraint provisions, as contended by the franchisee, would effectively allow the franchisee to misappropriate to itself the benefits of the franchisor’s business relationships and the very reason the restraint provisions were there in the first place was to protect the franchisor’s interest in the goodwill of its business.

Being careful to note that at this early stage of the proceeding the court could not determine what the ultimate interpretation would be, Nation J accepted that the interpretation contended for by the franchisee was seriously arguable. He observed there was no express provision against the respondents being involved in providing a service similar to that of the franchised business, to a real estate firm as an employee of that firm and accepted that restraints of trade provisions should be interpreted strictly, which I fully agree with. Nation J also noted that the contra proferentum rule would apply so that it was arguable that the interpretation most favouring the respondents (being the non-drafters of the franchise agreement) would apply.

In terms of the balance of convenience, Nation J accepted the respondent’s submission that the measure of goodwill and loss of income that would be lost by the plaintiff (if it succeeded in its substantive claim) was likely to be modest and, further, that it would not be difficult to establish an appropriate starting point for assessing such a loss in any event.

This viewpoint seems a little surprising given that in restraint of trade cases generally, damages are normally not regarded as an adequate remedy. In Amalgamated Pest Control Pty Ltd v SM & SE Gillece Pty and others [2016] QCA 260, (at [40]), the Supreme Court of Queensland summarised the reasons why damages are often regarded as being inadequate in restraint of trade cases, being as follows:

  • the difficulty of detection of breaches of the obligations;
  • the difficulty of establishing causation between any loss of business with customers and any actions of the ex-employee; and
  • the difficulty of the calculation of the quantum of any damage arising from loss of business.

Another recent decision

In another recent interim injunction decision involving a restraint of trade clause in a franchise agreement, Supatreats Asia Pte Ltd v Grace & Glory Ltd [2018] NZHC 1612, the defendant franchisee also sought to downplay the significance of the plaintiff’s losses, submitting that damages are an adequate alternative remedy because their calculation in a franchise dispute is a relatively easy exercise. They pointed to the franchise agreement and submitted that the quantification of damages could easily be achieved by calculating the ongoing franchise service fee that the franchisor would be missing out on, going forwards. In other words, their argument was that the only loss that would be suffered would be the loss of ongoing franchise fees, completely ignoring the question of any particular damage as a result of loss of goodwill.

The argument was not surprisingly rejected by Wylie J because in that case, the actions of the defendants in hurrying up a rebrand of the entire system once proceedings had issued had clearly undermined the plaintiff’s entire New Zealand franchise operation. Wylie J was of the view that it is difficult to see how a damages figure could readily be put on that sort of loss, and that ongoing activities to undermine the master franchisor’s business would cause a significant loss to the plaintiff if it continued unchecked. Importantly, he mentioned the loss that would extend to the loss of goodwill and the brand built up over a 30-year period, finding that damages could be very difficult to establish.

Returning to the Open2view case, the ultimate finding was that the application for injunction was declined. Practitioners who advise in this area will no doubt keep the keen eye out for any substantive decision.

It is important to franchisees that they are entitled to rely on the strict wording of restraint of trade clauses in franchise agreements. It would not be unusual for franchisees to seek legal advice on the scope of a restraint of trade obligation well in advance of their agreement terminating by effluxion of time. They do this because they want to know well ahead whether certain competitive activities are possible, so that they can plan their affairs accordingly.

Where the agreement itself is drafted by the franchisor, it should follow that the franchisor will have included all obligations it regards as necessary to protect its legitimate interest. It is perfectly reasonable that any ambiguity be determined against the franchisor. This is further reason why it is important that franchisees should be entitled to rely on the strict wording of restraint of trade clauses.

Deirdre Watson is a barrister and mediator specialising in franchising disputes. She is Vice-Chair of the Franchise Association of New Zealand.

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