Restraints of trade update and comparisons with employment contract restraints

Restraint of trade clauses are a common device used for the protection of a franchisor’s IP and system.

There are two things that need to be present in order for such clauses to be enforceable. The first is that there needs to be a “protectable interest” owned by the franchisor, meaning Intellectual Property, Trade Secrets, confidential information and the like. The second is that the clause must go no wider than is necessary to protect that “protectable interest”. If it does, the clause will be found to be unreasonable and therefore unenforceable.

The Courts have had little difficulty in appreciating that in franchising, the methodology, system and associated Intellectual Property (often including trademarks and branding) will amount to the necessary “protectable interest” (with the reservation that by no means should that ever be assumed). The real question with restraints is whether they are reasonable as to their duration, geographical scope and in terms of the activities they seek to restrain. They will be unreasonable if they go beyond a reasonable protection for the “protectable interest”.

In terms of duration, the “going rate” for the acceptable duration of a restraint in franchising was often thought to be two years. I say that because that period of time was the time frame most often seen in restraint of trade clauses in franchise agreements. However, since the SKIDS case, which found a more reasonable period of time to be 3 months, my view is that two years would now be regarded as well in excess of a reasonable period of time.

It is important to remember that with retratint of trade clauses, this is not a one size fits all standard. The SKIDS case was a timely reminder of the need to look at the issue on a case by case basis. Fundamentally, the rights of the franchisor to protect their property need to be balanced again the right people have to earn a living, to work, and to use skills they have acquired in the course of their working life.

There are many synergies in the area of restraints of trade clauses with the way in which those clauses are interpreted in the Employment field, in which I have had a lot of experience also in seeking to enforce restraints. Employment relationships are akin to franchise relationships in a way in that, in both, there is an ongoing relationship between the parties. Both are a form of relational contract.

Many franchise lawyers would regard franchise agreements as being subject to an implied obligation of good faith. Employers are subject to a legislated obligation of good faith, pursuant to section 4 of the Employment Relations Act. This means they must treat employees with fairness at all times. There are clearly some conceptual similarities between the two types of relationship.

In the employment context, it is fair to say that restraints of 3 to 6 months tend to be, roughly, the generally accepted norm for enforceability, depending on the seniority of the employee and the type of business involved. Further, such restraints are more likely to be enforced if they are only seeking to restrain contact by the employee with customers of their former employer, rather than restraints which prevent any type of work at all in the industry.

In a recent employment case, the novel issue arose of whether a period of garden leave (leave imposed at the end of a contract) should be taken into account in determining whether a 6 month restraint was reasonable.

The facts of the employment case were that the Employee in question was employed by Air New Zealand, as the General Manager of Air Nelson, which is the largest of the three regional airlines. The Employee had a 6 month restraint of trade clause in his employment contract. He also had a 6 month notice provision in his contract and Air New Zealand had the right to put him on “garden leave” in the event he gave such notice. In practical terms, that effectively increased the actual duration of the restraint to 12 months because if garden leave was imposed, it would be 12 months in total that the Employee would be out of the industry.

The inevitable happened, the Employee received an offer from Jet Star. He gave his 6 month’s notice and was placed on garden leave.

The Employee argued that a restraint of 6 months was unfair, given he had already been on garden leave for 6 months. The Court agreed and found that a garden leave provision should be taken into account when the Court was considering reasonableness of the duration of any post-employment restraint.

There are potentially some lessons for franchising here. First, the case is a useful insight generally into the question of duration, which the Court found to be reasonable at 6 months, despite Air New Zealand arguing for a longer period. The Employee in question was a very senior employee, with access to confidential information, and was going to work directly for a competitor.

Second, the effect of a garden leave provision is arguably analogous to the franchising scenario where a dispute arises, the franchisor locks the franchisee out of the system, stops feeding them leads, yet does not formally terminate the agreement. In theory, the franchisee is already locked out of the industry before a restraint period even kicks in. Where a franchisee is already not getting any services prior to termination, that period of time could in my view be arguably taken into account in deciding if the restraint is reasonable.

November 2014

Please ask permission if you wish to reproduce any part of this article.