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FRANCHISE RESTRAINTS: CASE-BY-CASE APPROACH MEANS OUTCOMES VARY

by Deirdre Watson,
last updated 28/10/2016

October 2016 – Deirdre Watson shares three lessons on the most recent High Court cases involving restraints of trade and good faith in franchising

In the last few years, in three well-publicised cases, the High Court has granted interim injunctions to uphold restraint of trade clauses[1]. In the best-known of those three cases, Health Club Brands Ltd v Colven Botany Ltd[2] (the Club Physical case), the High Court sent a very strong message to a franchisee who had wrongly cancelled their franchise agreement that illegal behaviour followed by breach of a restraint of trade clause would not be tolerated. That case served as a sobering reminder to franchisees (and those advising franchisees) of the need to ensure that there are legitimate grounds of cancellation before seeking to terminate a franchise agreement.

In the paper I presented to lawyers at the Auckland District Law Society last month[3], I examined this trend of robustness in the restraint of trade area and concluded that although the trend was good news for franchisors (where there was a strong established brand), each restraint of trade fact scenario still needs to be individually examined on its merits, and that one cannot assume, simply because there is a franchise system involved, that the restraint clause will be upheld.

The most recent case to be heard in the High Court (June 2016)[4] has provided a stark illustration of what I was talking about and also raises important issues concerning good faith in franchising.

Background

The case involved the Green Acres franchise system. Mr Hoover was a Green Acres sub-franchisee in the Te Awamutu region. He had a franchise from Dorn Investments Ltd (Dorn), which was the relevant franchisee in the Waikato region. Dorn appears to have effectively been a Master Franchisee, having sub-franchised approximately 14 independent sub-franchises in its territory providing lawn and gardening services to approximately 1,500 customers.

Mr Hoover was approximately 60 years old and lived in Te Awamutu, in a home in which there was approximately an equity of $60,000. His other assets were chattels and vehicles used for his business worth about $35,000. He was plainly an individual of modest means.

He entered into his sub-franchise agreement in January 2013.  There was a restraint of trade clause in the agreement which restrained him from competing with the business of the franchisor within New Zealand for two years from termination.

The relationship deteriorated over time, with Mr Hoover forming the view that he had not received a good return for his investment in the franchise. He also formed the view that the previous sub-franchisee was breaching his restraint of trade by carrying out lawn mowing in his part of the Waikato territory. He also believed he had not received promised training. This was all disputed by Dorn, as you would expect.

In September 2015, Dorn became unhappy with the way in which Mr Hoover was carrying out the work for a significant client, Spotless, and it took the contract off him and gave it to another franchisee, as it was entitled to do under the agreement. There was no requirement in the contract for Dorn to observe procedural fairness to Mr Hoover.

The Spotless work accounted for a large part of Mr Hoover’s turnover, and Mr Hoover was understandably disgruntled that he had never been given an opportunity to rectify any areas of concern before the contract was taken away.

Mr Hoover therefore responded by simply rebranding and commencing trading on his own account. He did so by rebranding as the Lawn Ranger, advising his approximately 50 clients of the change. He destroyed the Green Acres business cards and signage, he claimed he never had a manual, and claimed that he had not been in any way utilising the Green Acres goodwill.

Dorn terminated the agreement and then later filed proceedings seeking an interim injunction to restrain Mr Hoover from providing lawn and gardening services in competition with the Green Acres business in New Zealand[5].

The lawyer for Mr Hoover argued that procedurally the process of removing the Spotless work from Mr Hoover was carried out unfairly to him, even although there was no contractual requirement of procedural fairness (as there would be if, say, Mr Hoover has been an employee of Dorn’s[6]).

Seriously arguable

The Judge noted that there was no express term in the franchise agreement requiring Dorn not to take any work away from a franchisee, or to follow a certain process before any such work is taken away. However, the Court was of the view that it was seriously arguable that there could be an implied term in the franchise agreement to that effect. His Honour said[7]:

‘It would be surprising if a franchisor or sub-franchisor such as Dorn Investments, controlling the allocation of significant work as it did, could take away one-third of a contractor’s turnover without at least giving the franchisee the opportunity to rectify the complaint that was the basis for the removal.’

The Court declined to grant the injunction. Whilst accepting that a franchisor could protect its interest by use of a restraint, the Judge was of the view that the complaints about the ‘removal’ of the Spotless contract had substance.

The Judge then went on to specifically refer to the fact this would be an allegation ‘akin to there being an implied term of good faith’, stating:

‘I also accept that there appears to have been some measure of dissatisfaction on the part of Spotless at Mr Hoover’s performance more generally, and that it might well be shown that he had fallen short of what could be expected of a sub-franchisee by a considerable margin. However, on the face of it Mr Hoover was given no opportunity to address this serious complaint, and it was specific to not doing gardening over a short mid-winter period. Given that he would be paid for his attendances; it may have been easily remedied. He was not given that opportunity.’

The Court concluded that Mr Hoover may be able to put forward a defence to the claim to enforce the restraint of trade clause.

The Court then went on to find that on the balance of convenience and overall justice, no injunction should be granted, noting that Mr Hoover could be out of employment and also that ultimately damages would not be significant.

Three lessons

In my paper presented to the Auckland District Law Society[8], I discussed the nature of the obligation of good faith which applies when a party to a contract is exercising a contractual discretion, including the discretion to terminate a franchise agreement. That law would apply here, if Dorn was exercising a contractual discretion when it took away the Spotless contract.

I am of the view this most recent Green Acres case is important to franchising for three reasons:

a) It shows the willingness of the High Court to delve into the facts of each franchise case (on a franchise by franchise basis) to determine whether a restraint should be upheld. As I have said before, it can and should never be assumed that just because there is a franchise involved, the restraint of trade clause will automatically be upheld[9].

b) The case highlights the uphill battle franchisors face on interim injunctions, when the balance of convenience lies in favour of the franchisee (as so often happens). Clearly weighing on the Judge’s mind in this latest case was the modest financial position of the franchisee and his need to earn an income.

c) I believe the most important aspect of the case is that it shows the openness of the Court to entertain arguments of good faith. An implication of a term of procedural fairness when a franchisor is exercising a contractual discretion would create waves in franchising, and in particular, in cleaning franchises where franchisors perceive that they need to control this aspect of the agreement. If franchisors have to observe procedural fairness towards franchisees, then the relationship between them and the franchisee would be increasingly akin to that of an employment agreement.


[1] Video Ezy International Pty Limited V Red Bond Limited [2015] NZHC 1636, Mike Pero (New Zealand) Ltd v Heath and Others [2015] NZHC 2040 and Health Club Brands Ltd v Colven Botany Ltd [2013] NZHC 428.

[2] [2013] NZHC 428.

[3] http://www.deirdrewatson.co.nz/articles/143-auckland-district-law-society-presentation-on-common-disputes-in-franchising-31-august-2016

[4] Dorn Investments Ltd v Hoover [2016] NZHC 1325

[5] It is likely that Dorn was obliged, under its agreement with Green Acres, to bring such enforcement proceedings.

[6] S 4 of the Employment Relations Act 2000.

[7] At paragraph 30

[8] http://www.deirdrewatson.co.nz/articles/143-auckland-district-law-society-presentation-on-common-disputes-in-franchising-31-august-2016

[9] At least not on an interim injunction basis.

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