February 22, 2012

Restrictive competition covenants – Part 2

This is Part 2 of a 3-Part series. View Part 1 and Part 3.

By definition, an in-term non-compete covenant operates contemporaneously with the other covenants in the franchise agreement that are designed to regulate the franchise relationship operationally while it continues.  The in-term non-compete covenant may be a logical consequence of these other covenants (for example, a covenant to devote one’s entire working time and attention to operating the franchise), or it may be entirely unrelated to them.  If the former is true, then the doctrine of restraint of trade has no application in the first place, and the court will enforce the in-term non-compete even if its effect is to restrict the franchisee’s freedom to trade.  If the latter is true, however, then the in-term non-compete is simply a “naked” restraint on trade and the court will subject it to the three-part reasonability test we described in Part I of this blog thread.

In contrast, a post-term non-compete covenant operates after the franchise relationship ends, and so can never be a logical consequence of franchise agreement covenants that apply during the franchise term. Being thus a “naked” restraint on trade, the court will always apply the three-fold test of reasonableness to a post-term non-compete covenant.  It follows that if the court is inclined to view the particular franchise relationship in question as lying closer in the spectrum to one of employment rather than to the sale of a business, then the franchisor will have to try to support the non-comp covenant as necessary to protect its trade secrets, confidential information, and the outlet’s trade connection.  But, absent special circumstances, the court is likely to find that a reasonable secrecy covenant and reasonable non-use covenant would adequately protect the franchisor’s proprietary information, and a reasonable non-solicit would adequately protect the outlet’s trade connection, and so find that a non-compete covenant is overreaching in the circumstances, and so is unenforceable.  In the right circumstances, however, the franchisor may be able to prove that the very nature of its trade secrets and confidential information is such that it is impossible to know whether or not the ex-franchisee is using them in his or her new competing business, so that only a (reasonable) non-compete covenant will suffice.