Business Law & Compliance

Post restrictive covenants: How far can you restrict franchisees?

5 min read

20 August 2014

We are asked frequently by franchisors how far they can go to restrict a franchisee from competing with their businesses during and after termination of the franchise agreement. Paul Cox uses a recent court battle as a case in point.

In the recent decision of Carewatch Care Services Limited vs Focus Caring Services Limited and others, the High Court has given guidance on what restrictions may be reasonable.

Carewatch is the second largest provider of home care services in the UK. It operates through a combination of directly-owned corporate branches and outlets run by franchisees. Over the last five years, the balance has shifted significantly from the franchise side of the business towards an increase in directly owned branches. As a consequence, a considerable number of Carewatch’s franchisees have become dissatisfied with the support they’ve received and suspicious that Carewatch was deliberately trying to run down the franchise side of its operations in favour of its own branches.

Matters came to a head at the start of this year when Focus (one of the franchisees) wrote to Carewatch to assert that the company was in repudiatory breach of implied terms. They accepted those breaches and claimed that they were discharged from their post-termination covenants and were unenforceable in any event.

Carewatch issued proceedings to enforce the covenants.

The main findings of general relevance in the case were as follows:
The Defendants argued that as franchise agreements require “a significant commitment of time, money, mutual trust, confidence and loyalty between the parties” certain terms should be implied into the contract such as: a) Carewatch had an obligation to act in good faith; and b) Carewatch should work to improve and develop the franchise network for the benefit of both parties. The Judge rejected these arguments and held that, as the franchise agreement was detailed, there was no need to imply any terms into the agreement to make it work.

Carewatch was not in repudiatory breach of the agreement; the judge found that that the arguments to the contrary were “hopeless on the facts”.

The following restrictive covenants were lawful to protect the legitimate interests of the franchisor, namely the franchisor should not:

  1. For 12 months after termination be engaged in, employed by or be concerned or interested directly or indirectly in any business which competes with the business or the franchisee’s business or in any business similar to the business in the territory;
  2. For nine months after termination be engaged in, employed by or concerned or interested directly or indirectly in any business similar to the business within the territory of another franchisee of the franchisor;
  3. For 12 months after termination indirectly or directly solicit or tout for business from customers who were customers of the franchisee at any time in the 12 months period prior to termination; and
  4. For 12 months from termination indirectly or directly solicit, interfere with or endeavour to entice away or employ any employee of the franchisor or any of the franchisor’s franchisees or any employee which in the period of six months before the said termination was an employee of the franchisee’s business.

The judge highlighted that the legitimate interests of the franchise or could include protecting the goodwill, confidential information, know-how, employees and customers of the business. 

The judge found that all the defences raised by the defendants failed. Carewatch was entitled to injunctive relief to enforce the restrictive covenants and the “step–in” provisions (which allowed Carewatch to take control of the defendants’ business and pay a market rate for the assets). Further, Carewatch was entitled to damages against all three defendants.

This highlights that franchisors have the ability to include extensive post termination provisions in franchise agreements to protect their legitimate business interests. From the franchisee’s perspective, it is key to take independent legal advice to ensure that it understands the scope of any restrictions in the agreement and avoids the risk of either having the agreement terminated or being liable for damages as a result of a breach of the agreement.

Paul Cox is a member of the franchise group at Clarke Willmott.