Restraint of trade clauses - an update

Many advisors with an interest in restraint of trade clauses in franchising have been keenly following the passage through the Courts of a case decided in 2011, in which the High Court found that the franchisor’s restraint of trade clause was unenforceable (SKIDs Programme Management Ltd v McNeil). The High Court decision was appealed and, 23 July 2012, the Court of Appeal handed down its decision.

This article deals with some of the restraint of trade aspects of the decision.

As most are aware, it is well accepted law in New Zealand (and elsewhere in the Commonwealth) that contractual terms that contain a restraint of trade provision are prima facie void and therefore unenforceable. That cornerstone tenet of restraint of trade law has its origins in public policy, being a reflection of what is considered desirable in the public interest.

The needs of the “public interest”, however, equally dictates that in not every case should restraint of trade clauses be unenforceable. Therefore, where the party seeking to enforce the restraint (eg, the franchisor) establishes that a restraint is reasonable, it may nevertheless be enforced.

The starting point is that the franchisor must show that it has a “protectable interest” to justify the imposition of a restraint. That, of course, will generally always be the case where the franchisor provides use of branding, logos, other intellectual property, updated specialist knowledge and assistance, and updated and current operations manuals which normally (at least in a perfect world) contain all the secrets and business methodology as to how the system works.
The more critical aspect, and that least properly understood, in my experience, is that, once it is established the franchisor has a “protectable interest”, a restraint of trade clause must go no wider than necessary to protect that interest. It must not restrain activity over a geographic area or for a period of time which is over and above what might be considered reasonable, in order to genuinely protect a franchisor’s interest.

In assessing whether a restraint of trade clause is reasonable, the restraint is not examined in isolation. Other terms of the franchise agreement come into the mix. In particular, the other provisions of the agreement which protect the franchisor’s intellectual property and provide for the franchisor to have some ongoing control over the franchise, such as a right of election to buy the franchise business or assets at the end of the term or the right to control the lease relating to the franchised business.

As to the duration of a restraint, a rule of thumb I have sometimes heard expressed (bearing in mind every system needs to conduct its own enquiry as to what is reasonable) is how long would it take to set up a new franchisee in the territory?