A: Non-competition and non-solicitation clauses are common restrictive covenants in franchise agreements.
That’s because non-competition clauses prohibit franchisees and their principals from operating a business that competes with the franchisor. What constitutes a “competing business” will vary from franchise system to franchise system. However, franchisees can generally expect to be prohibited from being engaged in a business that offers goods or services similar to those of the franchisor.
Non-solicitation clauses prohibit franchisees and their principals from soliciting or “poaching” employees, clients/customers, or service providers from the franchisor or encouraging these persons to abandon their business relationship with the franchisor.
Both non-competition and non-solicitation clauses will usually apply during the term of the franchise agreement and for a period, usually one or two years, following the termination or expiration of the franchise agreement or following a sale of the franchise by the franchisee. Non-competition clauses are generally limited in geographic scope and only prohibit competition in a specific geographic area in relation to the franchise, other franchises, and corporate outlets.
Are non-competition and non-solicitation clauses enforceable?
Non-competition and non-solicitation clauses are essential to franchisors because they protect them from unfair competition by current or former franchisees who will have learned trade secrets and acquired confidential information from the franchisor during their franchise relationship. However, the scope of this protection isn’t without limit.
Courts will only enforce non-competition and non-solicitation clauses that are unambiguous and reasonable. A clause will be ambiguous if it could be interpreted more than one way or is otherwise unclear as to what is protected. Reasonableness, on the other hand, is assessed based on the duration and geographic scope of the clause and the nature of the prohibited activities.
Courts will examine non-competition and non-solicitation clauses to ensure that they don’t go beyond protecting a franchisor’s legitimate interests. Provisions that prohibit franchisees from engaging in activities beyond the scope of its franchised business activities—which last for an unreasonable period of time or cover an overbroad territory in which the franchisor has no legitimate business interests—may not be enforceable in court. However, if a non-competition clause is properly tailored to be unambiguous and reasonable, the franchisor will likely be able to enforce the clause.
How can non-solicitation clauses affect franchisees?
Franchisors have a variety of legal tools at their disposal to enforce non-competition and non-solicitation clauses, including actions for damages for lost business and applications injunctions ordering the infringing franchisee to comply with the terms of the clause. Even in cases where the franchisor is ultimately unsuccessful, defending an action or injunction for infringement of a non-competition or non-solicitation clause is expensive and time-consuming for a current or former franchisee. As such, these clauses will significantly hinder a franchisee’s ability to operate or engage in a competing business regardless of the clause’s ultimate enforceability. Therefore, franchisees are strongly encouraged to treat all such provisions as if they’re enforceable.
That said, franchisees can protect their interests and ability to earn a livelihood following termination of their franchise agreement by negotiating the scope and other terms associated with non-competition and non-solicitation clauses. For instance, franchisees in large metropolitan areas may seek to limit the geographic scope of these clauses to allow them to continue operating a similar business without the need to relocate to another city. Similarly, franchisees who enter a franchise system with an existing portfolio of competing businesses should always seek an exception to non-competition clauses for those existing businesses.
The best time to negotiate non-competition or non-solicitation clauses is at the outset of the franchise relationship before a franchise agreement is signed. However, franchisees should temper their expectations when negotiating such clauses. As mentioned above, these clauses are essential to protecting a franchisor’s interests. Without non-competition and non-solicitation clauses, franchisors may hesitate to invest time, resources, and know-how in franchisees. As such, it’s unlikely that franchisees will score anything more than minor reductions to the temporal or spatial scope of such clauses or exceptions for the franchisee’s existing businesses. Concessions on restrictive covenants are highly unlikely following the termination of a franchise agreement or breakdown of a franchise relationship.
Franchisees who are subject to non-competition or non-solicitation clauses must exercise caution in deciding whether to take potentially competitive action against a franchisor. Franchisees can best protect their interests by negotiating exceptions to these clauses before entering into a franchise relationship. However, if the franchise relationship breaks down or otherwise ends, franchisees can reduce the risk of litigation by seeking early legal advice on the scope and enforceability of any non-competition or non-solicitation clauses to which they’re subject.
Chris Pelkey
Lawyer
McInnes Cooper
chris.pelkey@mcinnescooper.com