Restraint of Trade prevents unfair competition

Restraint of Trade prevents unfair competition

 

Khushbu Sundarji

Auckland, July 21, 2019

All franchise agreements contain a Restraint of Trade provision in which the Franchisee is not permitted to be involved in a similar business to the franchised business for a certain period and within a certain area, after the termination or expiration of the franchise agreement.

Franchisors can take action to enforce the Restraint of Trade provision in the franchise agreement as seen in the two cases below.

Mike Pero (New Zealand) Limited v Heath 27 August 2015

Mike Pero Mortgages is a well-known mortgage broking franchise.

Heath signed a franchise agreement with Mike Pero in 2010 which included a Restraint of Trade provision.

In 2015, Heath advised Mike Pero that he did not want to renew the franchise agreement.

Heath then incorporated a new company and set up a business in direct competition with Mike Pero.

Mike Pero discovered the new business and filed for an interim injunction for breach of the Restraint of Trade provision in Heath’s franchise agreement.

Mike Pero argued that the Restraint of Trade provision in the franchise agreement stopped Heath from being involved in a competing business. Heath argued that the restraint was unreasonable and that Mike Pero did not have any goodwill in its business to protect.

Court decision

The Court sided with Mike Pero and noted it was significant that Heath was advised of the restraint when he signed the franchise agreement and did not object to it; and that in spite of the restraint, he set up a business competing with Mike Pero.

Supatreats Asia Pte Ltd v Grace & Glory Ltd July 2, 2018

Supatreats Asia Pty Ltd (the Franchisor) signed a master Franchise Agreement with Cone Enterprises Limited (Cone) in 2015 for Cone to be the Master Franchisor for the Wendy’s Supa Sundaes franchise in New Zealand.

In 2017, the parties fell out over a proposed ice cream supplier.

Cone and the sub-franchisees argued that the quality of the proposed supplier was expensive and inferior to the current supplier.

The Franchisor issued breach notices to Cone and the sub-franchisees to force them to use the new supplier, but Cone and the sub-franchisees refused to comply.

New Ice Cream Parlour

Subsequently Cone opened an ice cream parlour called Shake Shed (which was similar to Wendy’s) and other sub-franchisees surrendered their existing Wendy’s franchise agreements, re-branded and joined Cone in its new venture.

The Franchisor discovered the new stores and served notices on Cone and the sub-franchisees advising that the re-branding of the stores was in breach of their Restraint of Trade provisions in their respective franchise agreements.

The Franchisor ultimately terminated the Master Franchise Agreement in 2018 with Cone and then issued proceedings against Cone and various sub-franchisees for (among other causes of actions not discussed here) breach of their Restraint of Trade provisions.

Interim injunction

The Franchisor argued that the interim injunction was necessary as there was a serious possibility of damage of its goodwill. Cone and the sub-franchisees argued that the Restraint of Trade provisions were unreasonable and that if the injunctions were granted it would cause considerable financial distress to force the sub-franchisees to close their stores given that the roll out of the Shake Shed stores was complete.

The Court sided with the Franchisor.

The Court noted that it was significant that Cone and the sub-franchisees rebranded in the face of the express notice from the Franchisor which clearly stated the consequences if the parties continued to re-brand to Shake Shed.

Furthermore, Cone and the sub-franchisees had been advised of the restraint when the franchise agreements were signed and never argued that the Restraint of Trade provisions were unreasonable at that point. 

Reasons for Restraint

The Courts recognise that restraints are necessary for commercial reasons. 

Restraints protect the business of the franchisor who may have spent many years building up the goodwill of the business.

However any restraint should be reasonable.

For example, a restraint of five years throughout New Zealand could be seen as unreasonable and Courts have options under Section 83 of the Contracts and Commercial Law Act 2017 to read down unreasonable restraints, even if both parties agreed to it.

Franchisees are encouraged to seek legal advice before signing the franchise agreement so if you have any questions you should contact us.

Khushbu Sundarji is an Associate at Stewart Germann Law Office. Email: khushbu@germann.co.nz

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