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Can a franchisor still prevent its ex-franchisees from competing?

By : Alexander Goold

The recent High Court decision in Fleet Mobile Tyres Ltd v Stone and Ashwell [2006] EWHC 1947 (QB), has major implications for franchisors seeking to impose a one year, territory-based post-termination restraint of trade clause on their ex-franchisees. This case, and its appeal to the Court of Appeal [2006] EWCA Civ 1209, also has a significant impact on franchisors wishing to re-brand their business or sell through websites. This article focuses on an aspect of the decision that was not the subject of appeal. Its potential impact may have been overlooked.

 

Fleet run a tyre fitting franchise operated by franchisees in exclusive territories. It started a website called eTyres and agreed charges with customers who purchased the service via the website. It then provided the work to the local franchisee but paid the franchisee a lower fee for the work than the price paid by the customer mainly to fund the costs of administering the website. Fleet subsequently decided to re-brand the whole of its business as eTyres and instructed franchisees to change their advertising and van liveries.

Stone and Ashwell objected, arguing that that the re-brand instruction was  a derogation from the grant of the franchise which entitled them to trade as Fleet Mobile Tyres. They also contended that the franchisor was acting unlawfully in deducting a proportion of the price on eTyres work which, they said, made it less profitable for them. They argued that the breaches were so serious they were repudiatory and unless rectified they would elect to treat the franchise agreement as coming to an end. Fleet threatened to terminate too, but after the date stated by Stone and Ashwell.

So far, a not untypical falling out between a franchisor wishing to expand and improve its business in a particular way and a franchisee who does not.

In due course, Fleet issued proceedings claiming the usual post-termination injunction. The precedent for an injunction is well established in a franchise context since the leading cases Dyno-Rod & Anor v Reeve & Anor (1999) FSR 148, Prontaprint v Lando Litho (1987) FSR 315, Kallkwik Printing (UK) Ltd. v Rush (1996) FSR 114 and Convenience Co. Ltd v Roberts & Others (2001) FSR 35. A one year territory-based post-termination restraint of trade clause has regularly been upheld as reasonable to protect the legitimate business interests of the franchisor.

It is important to remember that a restraint of trade clause is not about punishing an errant ex-franchisee. It is only enforceable to protect the legitimate business interests of the franchisor. This is generally seen as the ability to retain the goodwill, including the name and customer base, in the former territory, in particular with a view to selling it to another franchisee. It helps with both the recruitment of the new franchisee and his/her initial establishment in the territory if s/he will not face unfair competition from an individual who knows the territory, its customers and the franchised system inside out because of the training, know-how and support that individual received whilst a franchisee.

In ‘Fleet’ the franchise agreement contained a non-solicitation clause that for one year the ex-franchisees would not solicit business from their former customers. The Judge readily upheld that clause. But he was troubled by the one year period of the territory-based non-competition clause. Despite the territory being large he agreed that it was reasonable to prevent the ex-franchisee competing there but his opinion was that 12 months was too long (although he would have been prepared to uphold 6 months as reasonable). Accordingly, the non-competition clause failed.

 The Judge had a number of reasons for holding that only 6 months was reasonable. Broken down they can be simplified as:

  1. Fleet retained a greater than normal degree of control over the franchisees’ business, including branding and some elements of pricing.
  2. One of Fleet’s franchise managers had treated the franchisees like ‘truculent employees’ not as owners of businesses.
  3. Customers would need to use the service frequently and, with the benefit of the non-solicitation clause, those customers would be free to go to other suppliers including the new franchisee early on.
  4. There was very little damage an ex-franchisee could do once restrained by the non-solicitation clause.
  5.  

Other matters that the Judge considered, that will be of interest and possible concern to franchisors, were as follows: 

  1. The ex franchisees had paid what was said to be ‘a significant sum’ up front for the franchise, (although £28,000 for 2 territories is not an unusual sum these days);
  2. The estimated net profit for the franchises as set out in the franchisor’s information pack was found to be almost certainly excessively optimistic and it was said not to be a case where the franchisee was going to generate an immense income. (Franchisors may want to review the accuracy of their promotional material in the light of these comments);
  3. Although the franchise was a business and not simply a ‘man in a van’, the people providing the service in many cases had little business experience or acumen. (Does this suggest that franchisors are less likely to receive protection from competition from a ‘one man band’?);
  4. The impact of the ex-franchisees’ services was likely to be localised within certain parts of the territory.
  5. The franchise was largely based on the use of a brand name, (which was changing), which was not a well known brand or market leader and was in an area of high competition with independents and garages. The amount of goodwill built up by the ex-franchisees would be limited by these factors.

What is unsatisfactory about the judgment is that the Judge did not expressly deal with why, on the one hand, he thought a period of 12 months was reasonable for the non-solicitation clause but, on the other, only 6 months was reasonable for the non-competition clause.

The Fleet case is fact specific but franchisors cannot now assume that a period of 12 months will be upheld as a matter of course in a post-termination restraint of trade clause and will need to justify why this length of time is necessary. This may include showing the Court the ways that their own franchises differ from how Fleet was running theirs at the time.

What does this decision mean for franchisors hoping to manage their networks and prevent ex franchisees from competing? Ironically, well known brands and market leaders (who, being well established, might be thought to need less protection) should have fewer problems. The difficulties lie for smaller franchisors, those starting up or operating in a highly competitive marketplace, (who might be thought to need to ask the courts to uphold post-termination restraints more frequently). Those franchisors may now wish to seek advice from their franchise lawyers about their own franchise agreements. Amendments may need to be made to the agreement and the business model may need be reviewed.

Alexander Goold is a Barrister at Hardwicke Building and a member of chambers’ franchise group.

Russell Ford is a partner at Owen White, heading the Dispute Resolution team.