Recent roundup on restraints

By Deirdre Watson, Barrister, September 2015

Introduction

Two well established New Zealand franchise systems have recently come under the spotlight of the High Court, Video Ezy (Video Ezy International Pty Limited v Red Bond Limited) and Mike Pero Mortgages (Mike Pero New Zealand Ltd v Heath and others). In both cases, the Courts upheld the restraints on an interim basis, pending the outcome of a trial on the substantive issues.

At first blush, the cases certainly appear to be a victory for franchising. I suggest a better analysis, though, is that they are a victory for those two franchisors, but with plenty of grey area still presenting itself in other franchise systems.

The Existing Law

A quick refresher on restraints: As we know, restraints of trade are not enforceable unless they are shown to be reasonable. This is a question to be decided on a case by case basis because there is no one size fits all in franchises. First, it must be shown that the franchisor has a “legitimate interest” justifying the protection of a restraint of trade clause. Second, it must be shown that the clause goes no wider than necessary to protect that “legitimate interest”.

What is a legitimate interest?

Exactly what amounts to a legitimate interest came under close scrutiny of the Court of Appeal in the SKIDS case in 2013. This case is possibly one of the few New Zealand cases to closely examine the point with the benefit of full argument following a trial. It is important that note that it did so in the context of determining the substantive issues in the case, rather than merely determining an interim injunction (as per the Mike Pero and Video Ezy cases referred to above), where the Court only looks at whether there is a serious question to be tried that a restraint can be upheld, and does not make substantive findings.

The point of mentioning SKIDS is that having an updated, unique and relevant procedures manual and other relevant documents was regarded as key to whether or not there was a legitimate interest. The Court said:

“Skids franchisees were provided with material including an operation manual, a policy and procedures manual, onsite manuals, a pricing structure, employment documentation, enrolment documentation, and Programme modules amongst other things. Materials that were provided were subject to ongoing revision. Specialised material was made available to enable franchisees to obtain CYFS accreditation. While the base material that constituted the inputs to franchise documents was widely available, the standard documents could not have been created without work and thought.”

In not every system are Operations Manuals professionally prepared. Nor are they unique, relevant or updated, for that matter. Central to franchise disputes will often be a dispute about whether they are even of any use or not.

A cornerstone of franchising is having a system of business methodology, capable of being franchised. If that system is not professionally or adequately documented (and reviewed regularly) then franchisors walk a very tight rope when they come before the Courts asking the Court to accept they have a legitimate interest to protect by a restraint on trading activity.

What do the latest cases mean for franchising?

The outcomes of the two recent cases were in many respects fairly predictable. Video Ezy and Mike Pero Mortgages are examples of solid, long-standing New Zealand systems, with, no doubt, comprehensive, relevant and documented systems in place and where barriers to entry mean that new franchisees in a particular territory need a decent breathing space to get a hold in the market without the distraction of a competing ex-franchisee. Without question those franchise systems were readily able to demonstrate a serious question to be tried regarding the necessary “legitimate interest” justifying the protection of a restraint.

More tricky though are the franchise systems where Operations and other manuals are not completed, are hugely outdated, are not comprehensive or, simply put, are just not relevant.

I hasten to add, a legitimate interest is not merely drawn from an Operations or Process Manual. It might arise from Trade Marks and other IP. But those rights are of course amply protection by the relevant legislation and also by other clauses in franchise agreements. They do not necessarily require the added protection of a restraint of trade clause because they are well protected elsewhere.

So, whilst there has been a good victory for the two franchise systems concerned, there is plenty of scope for restraints in my view to continue to be challenged, where the legitimate interest does not meet the required threshold.

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