Restrictive covenants in franchising

The relatively recent case of Dwyer (UK Franchising) Ltd v Fredbar Ltd [2022] EWCA Civ 889 considered how restrictive covenants are applied in the context of franchise agreements. Whilst the case itself did not set any particular precedent, it is a useful illustration of the courts’ approach to determining whether the restrictive covenants in a franchise agreement are enforceable.

Reasonableness test

Courts generally take a strict approach when enforcing restrictive covenants. If the clause is not reasonable, it may not be enforceable. The party imposing the covenant must show that it is being used to protect a legitimate business interest and that the level of restriction is reasonable in duration, scope and location. Reasonableness is considered on a case-by-case basis, assessing the factual and contractual background to the agreement. A restrictive covenant should not be designed to prevent legitimate competition, but to prevent a party obtaining an unfair advantage.

Dwyer (UK Franchising) Ltd v Fredbar Ltd [2022]

The Dwyer case involved an emergency plumbing franchise, Drain Doctor, which imposed upon its franchisees a covenant not to be engaged, concerned or interested in a similar or competitive business within 5 miles of the franchisees’ territory for 12 months after termination (a so-called “non-compete” covenant). Due to financial issues, the franchisee terminated their franchise agreement early, during the pandemic and found alternative employment in the same region, being his local area, with a similar business.

The franchisor sought, among other things, an injunction to prevent breach of the restrictive covenants. After an initial High Court decision, the case ultimately went to the Court of Appeal, which ruled that:

• Franchise agreements are not a special category of agreement for determining a restrictive covenant. The usual rules of reasonableness apply.
• Inequality of bargaining power is a significant factor in determining the reasonableness of a restriction. In particular, it has long been recognised that the courts will more readily strike down a restrictive covenant in an employer/employee relationship, rather than in a commercial contract, because of this dynamic. Franchise agreements are however usually entered into between an established franchisor business and a newly created franchisee, with a standardised agreement presented on a ‘take it or leave it’ basis without the franchisee having the opportunity to negotiate any of the terms. In this particular case, it was held that the franchise agreement was more akin to a contract of employment.
• Each case has to be considered on its merits. No general rule can be applied.

In this case and on these facts, the court held that the non-compete restriction was unenforceable. However the court was careful to specify that in other circumstances (including in respect of Dwyer’s other franchisees) a 12-month restriction could well be enforceable.

Whilst in this case, the franchise agreement was considered akin to a contract of employment, there is still a distinction between the two types of relationship. In particular the recent government policy paper, Smarter Regulation, which proposes a 3-month limit to post-employment non-compete restrictions, does not specifically apply to franchise agreements. Should this paper eventually result in legislation, it is unlikely to have direct application to franchise agreements however it is still likely to be used in future cases to illustrate what are considered reasonable restrictive covenants. Find out more on the Smarter Regulation policy paper.

Lessons from the case

Franchisors can take a number of lessons from this case:

• Tapered restrictions: The court emphasised that the reasonableness of a restrictive covenant is to be judged at the point it was originally agreed, not at the point in time when it was breached. In this case, the court considered that a new 12-month restriction at the end of a 5 or 10-year franchise agreement, when goodwill in the business will have built up, would be more reasonable than the same restriction imposed on a new franchise business that has only been operating in a new region for less than 2 years. Franchisors could therefore consider amending their standard agreements so that the restrictions are tapered depending on how long the franchisee has been operating their business.
• Ensuring that a franchisee knows the terms of their agreement. If a contract is effectively non-negotiable, a franchisor can reduce the issue of unequal bargaining power by providing an FAQ which sets out all of the restrictions, covering the key terms of the agreement within mandatory induction training or requiring a franchisee to take legal advice when setting up their business.
• Above all, think carefully about whether to enforce a covenant and take advice. Franchisors should be sure that they are acting reasonably, enforcing a reasonable covenant, rather than risk this being successfully challenged in court.