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WHO OWNS THE CUSTOMERS?
HIGH COURT DECLINES FRANCHISOR'S BID
FOR INTERIM INJUNCTION

by Deirdre Watson,
last updated 27/06/2014

31 March 2014 – The High Court has declined to grant an interim injunction restraining an ex-franchisee from continuing to trade following the expiry of the franchise agreement.

A recent case involving a former Green Acres franchisee raises some interesting issues, not just in the area of enforcement of restraints of trade, but also in regard to what happens to the list of customers or the franchised business itself at the end of a franchise agreement. It may also renew calls for some form of franchise legislation.

Briefly, the facts were that the defendants signed up to the Green Acres franchise for a 10-year term in January 2004. During the operation of their franchise they acquired a customer base, built up through the nationwide marketing of Green Acres, but also due to their own efforts. They claimed that, at the expiry of the agreement, 70 percent of their customers were not referrals from Green Acres.

As January 2014 approached, the defendants toyed with the idea of renewing their term for another ten years. However, they decided not to and instead, when the agreement ended, they re-branded and set about continuing to service their customers under their new brand.

Green Acres sought an injunction to restrain them from competing by trading with the customers on their customer list. Green Acres sought to argue that it owned the customer list.

Does expiry allow a different interpretation from termination?

The starting point was to examine the agreement itself. This contained many of the usual provisions we expect to see in a franchise agreement, including a restraint of trade clause which provided that the franchisee could not compete for two years following termination. The restraint of trade clause immediately followed a provision in the agreement relating to when the franchisor could terminate for cause. One of the first arguments raised by the franchisee, therefore, was that the restraint of trade clause only applied when the agreement was terminated by the franchisor, and not due to expiry.

The Judge did not comment in detail on this point, but noted that the restraint of trade clause was contained within a more detailed provision relating to what would occur when the agreement came to an end. This included other sub-clauses which one would expect to see whether the agreement was terminated for cause, or came to an end naturally, such as the requirement to hand back all the manuals and IP.

The case came before the Court as an interim injunction. As such, the threshold that a plaintiff needs to demonstrate is that it has an arguable case the restraint should be enforced. The Judge therefore merely noted the arguments for both sides, concluding there was an arguable case in support of the position of both parties.

Who owns the customers?

The second issue which arose was the question of who owned the right to service the customers following termination of the agreement.

Naturally, the franchisor argued it had a proprietary interest in the right to service the customers at the end of the agreement. However, the franchise agreement between the parties was silent on who owned the customer list, although there were the usual detailed provisions covering the fact that all IP and know-how would remain the property of the franchisor, following termination. Whilst the franchise agreement did not specifically mention the customer list, it did provide that in the event of any inconsistency, the terms of the Master Franchise agreement would apply. That agreement did have a provision in it which referred to the customer lists and said they belonged to the franchisor.

The Judge therefore found it was arguable that the franchisor owned the customer list, although he expressed the view that this might not be the case for customers who were not introduced to the business through Green Acres.

The balance of convenience

The case being an interim injunction, the next question was weighing up the balance of convenience. It was on that point that the franchisor failed, which meant it could not get an injunction against the franchisee. The exercise of weighing the balance of convenience involves assessing the adequacy of damage for a plaintiff, as against irreparable injury which might be occasioned to a defendant. This is a delicate balancing exercise and the question of irreparable injury is looked at from both sides (see David Munn’s article on Risk Management and the Club Physical case, where an injunction was granted).

The Court found that the size and structure of the Green Acres system (where there are multiple franchisees working in the same territory) meant there was no real risk of the defendant harming the integrity of that system.  He also thought it was of relevance that the defendant had actually got to the end of their term. He was of the view that Green Acres would have an adequate remedy in damages.

The matter is now going to arbitration, which would perhaps have been the best solution in the first place.

Agreements should be specific

I think the case is of interest on the topic of who owns the customer list on termination, especially where the agreement is silent.

Ordinarily, a customer list would comprise part of the goodwill of a business. It is the source of custom and revenue. To me, a customer list does not fit comfortably into the category of know-how or intellectual property.

Good agreements will expressly address the issue of who owns the franchisee’s business, including any customer list, at the end of the term. This is important because, in some franchises, all the value in the business is in the client list (or at least the right to service those clients). Yet, surprisingly, a large number of agreements do not address this issue.

Frequently, there will be a provision for a franchisor to elect to buy parts of the franchisee’s business on termination. In that scenario, it would be difficult to argue the franchisee’s business was owned by the franchisor on expiry, otherwise, why would there be a clause allowing the franchisor to buy it?

Should it be mandatory to take legal advice?

The defendant in this recent case was reported in the media as saying that they felt unfairly bullied by the franchisor. The defendant has clearly always proceeded on the basis they expected to own their customer list at the end of the agreement, in particular those customers they sourced themselves, but that is not certain. The franchisor, of course, has to set a precedent in the interests of certainty in their system, so the bullying criticism was probably unjust.

The issue could perhaps have been better addressed in their franchise agreement, so at least everyone would know where they stood at the end of the agreement. However, even had that been clear, it would not necessarily have been understood by the defendant.

This raises once again the need for everyone to get proper legal advice prior to signing a franchise agreement. While that may seem a significant additional burden on a business which has an investment level of just $10,000-$15,000, the alternative is that people like the defendants (who probably did not have any idea what their business would look like 10 years from when they started) can be in for a nasty surprise at the end of that time if they think they can just take the business and walk away.

This is an area where legislative protection requiring franchisors at all levels to provide disclosure documents, and franchisees at all levels to take legal advice, could be of value.

(Editor’s note: Members of the Franchise Association of New Zealand are required to provide a full disclosure document in accordance with its Code of Practice, and are also required to advise prospective franchisees to take independent legal advice or to sign a statement saying they have chosen not to do so. Green Acres is a member of the Franchise Association and was a member in January 2004)

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1
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Patrick Learmonth @ April 3rd, 2014, 09:22 AM

Thanks Deirdre - a pity this was only dealt with as an interim injunction. Better drafting of the restraint may have made for a different result here.

There is a tendency for goodwill, intellectual property and customer contracts/lists to be lumped together as "intangibles" - see REINZ Agreement for sale and Purchase of Business 4th edition. That might be appropriate for a business sale agreement but more care is needed for franchise and distribution agreements.

I have had instances where franchisors have been reluctant to clearly state that goodwill in all customers is owned by the franchisor - the reasoning being to not discourage the franchise from itself finding new customers. This case is a good example of the risks franchisors will face if the contract is unclear on goodwill and who owns it.

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