Restrictions which seek to regulate a party’s conduct after a contractual agreement comes to an end are often a feature of franchise agreements. They are also commonplace in a wide spectrum of commercial contracts, including shareholder agreements, share purchase agreements, consultancy agreements, distribution agreements, and even in general employment contracts. These restrictions are usually referred to as restrictive covenants.
The aim of such covenants is to prevent a contracting party from exploiting the knowledge, trade connections, and relationships which might arise from the contract, and then going on to set up a rival business interest utilising this information.
The difficulty of including such clauses has often been the question: are they enforceable?
The Court of Appeal has recently ruled on a noteworthy case for franchisors and franchisees which appears to have rendered many post-termination restrictions in many existing agreements either unenforceable or at risk. It is, at the very least, set to change the approach to drafting such restrictions in future agreements.
The ruling was made in the case: Dwyer (UK Franchising) Ltd v Fredbar Ltd & Anor (Rev1) [2022] EWCA Civ 889 (30 June 2022), on the enforceability of post-termination restrictive covenants in a 10-year franchise agreement.
The decision in this case is significant because it covers a restrictive covenant which prohibited a former franchisee from setting up another business, similar to the franchise, within the same geographical area after the termination of the franchise agreement.
The case:
The franchisor
Dwyer (UK Franchising) Ltd (“Dwyer”) is a substantial company with more than thirty “Drain Doctor” franchises covering over sixty territories. It describes itself as the UK’s largest full-service emergency plumbing and drainage company operating in commercial and domestic sectors, and its ultimate parent in Waco (Texas) is described by Dwyer as the world’s largest home service franchise business.
The former franchisee
Fredbar Ltd (“Fredbar”) was a franchisee of Dwyer from around September 2018 until the summer of 2020. Fredbar was operated solely by Mr Bartlett, and he set up the company for the purpose of joining the franchise.
The background:
Dwyer was the franchisor of the Drain Doctor franchise. It entered into a franchise agreement with Fredbar – a special purpose company incorporated to enter into the agreement – and Mr Bartlett, the director and shareholder of Fredbar.
On July 16, 2020, Fredbar wrote to Dwyer to terminate the agreement. In the proposed termination letter, Fredbar and Mr Bartlett argued that there was a lack of support from Dwyer, with unrealistic financial targets that Fredbar was not able to achieve without assistance from Dwyer.
Dwyer held Fredbar’s termination to be a repudiatory breach of the agreement and, as a consequence, decided to terminate the agreement themselves, approximately two years into the 10-year agreement, by way of a letter dated August 19, 2020.
The franchise agreement between Dwyer and Fredbar had included post-termination restrictions aimed at preventing the franchisee from engaging in a similar or competing business for a duration of at least one year after termination, within a fixed postcode area.
However, it subsequently transpired that Mr Bartlett had set up a new business called “Daily Drains”, which was trading in and around the same area contained in the prior franchise agreement. Dwyer, therefore, sought an injunction to restrain Fredbar and Mr Bartlett from acting in breach of the restraint of trade covenants contained in the agreement. It also sought damages for breach of the agreement.
Fredbar argued that negligent misrepresentations had been made by Dwyer before the agreement was concluded, and that Dwyer had failed to fulfil various obligations during the agreement, one of which included an alleged failure of Dwyer to comply with a ‘force majeure’ clause during the Covid pandemic.
This negligence, Fredbar argued, entitled Fredbar to rescind and terminate the agreement, and, whether the agreement was terminated by Fredbar or Dwyer, the restraints of trade covenants contained in the agreement were unreasonable and unenforceable.
The outcome:
During the summer of 2022, the Court of Appeal upheld the decision of the High Court that certain restrictive covenants were unenforceable, mainly due to the circumstances under which they were agreed, the length of time involved, and the territory in question.
The Court of Appeal was asked two questions:
· Whether the first instance judge erred by considering irrelevant and impermissible factors when concluding that the restrictive covenants were unenforceable.
· Whether the first instance judge made an error in concluding that any unreasonable section of the restrictive covenant clause could not be severed.
The Court again found in favour of the franchisee (Fredbar), and held that the restrictive covenants were unreasonable and, therefore, unenforceable for several reasons pertinent to the specifics of this case.
Primarily, the projections given by Dwyer were not realistic, and the failure of Fredbar was foreseeable, with dire personal consequences on Mr Bartlett – who had put his own family home at risk if the business failed.
Also, the Court found objectionable the fact that the fullest extent of the restrictions applied regardless of whether the contract was terminated after just one day or 10 years.
What does the ruling mean for franchise agreements?
The case highlights the enforceability, or otherwise, of post-termination restrictions across the entire spectrum of commercial contracts – not just franchise agreements. It illustrates that certain clauses may not be enforceable, and it should prompt franchisors to review their franchise agreements and ensure that there is a legitimate reason behind each clause – particularly when it comes to restrictions on post-termination trade.
If the clause cannot be defended as reasonable and legitimate, the courts are more likely to find it unenforceable, so it must be very carefully considered.
With all this in mind, reviewing existing contracts and redrafting where necessary may save businesses from finding themselves in the difficult position of discovering certain clauses are unenforceable in future disagreements.
If you have any questions relating to franchising, you can access support from the legal team here at Hutchinson Thomas. We are accredited by the British Franchise Association to act on legal matters for franchisors or franchisees. Whatever your challenge, dilemma or question, we’ll be happy to help.
For more information on franchise law matters, contact Darren Davies on 01792 439000 or email darren.davies@hutchinsonthomas.com