by Stewart Germann & Harshad Shiba
last updated 05/02/2015
AFTER YOU'VE GONE
- how restraint of trade and IP issues affect former franchisees and imitators
by Stewart Germann & Harshad Shiba
last updated 05/02/2015
The incidence of disputes in franchising is remarkably low given the size of the sector – surveys suggest they involve just 1-2 percent of franchisees each year. But when disputes arise, they can sometimes have special significance for franchisors and franchisees. Here is a brief review of three such cases which demonstrated how franchisors can use the Courts to protect their intellectual property.
Our first case involved a franchisor seeking a restraint of trade against a party not actually connected to a franchise agreement. What it showed was that the Court will not stand by and let a third party who has collaborated with an outgoing franchisee poach the customers of that business.
A franchisee entered into an agreement to operate a Cookright franchise in Invercargill, Southland and Central Otago. The franchise system is one where the individual franchisees provide kitchen cleaning services such as the cleaning of vats, removal and replacement of oils and fats, etc.
Various issues arose between the franchisor and the franchisee including a dispute about what products the franchisee could sell. The franchise agreement provided that the franchisee could not sell competing products, yet the franchisee was allegedly selling competing products through a separate business.
In the end, it was agreed that the franchisor would buy the franchisee’s operation for $70,000 on the basis (amongst other things) that there would be a smooth transition of the business operation, that the franchisee would send letters to assist in transferring customers to the franchisor and that the terms of the settlement agreement would be kept confidential.
Notwithstanding the settlement agreement, the Court found on the evidence that the franchisee consorted with a third party (who were the defendants in this case) to enable the defendants to poach the customers of the business prior to the agreed assignment date when the franchisor would take over the franchisee’s business.
The Issue & The Law
While there were several claims made by the franchisor in this case, the most significant question to be tried was whether the third party – which was not a signatory to the franchise agreement – could be stopped from dealing with the old customers of the outgoing franchisee.
The Court found that the defendants acted deliberately to interfere with the settlement agreement between the franchisor and the franchisee and in a manner which caused loss to the franchisor. The loss of the customers who should have been transferred to the franchisor under the settlement agreement impacted severely on the franchisor.
In the circumstances, the defendants were injuncted from being directly or indirectly engaged or involved with any business that competes with the franchisor’s business in the franchised territories (Invercargill, Southland and Central Otago) for a period of one month following the date of the Court’s orders.
This case sends a very clear signal that the Courts will not permit unscrupulous conduct by a party who wilfully interferes in the contractual relations of a franchisor knowing that such interference will cause a loss to the franchisor.
In our second case, an Australian franchise was granted protection against its image being copied in New Zealand. Muzz Buzz found that a local operator here was using a strikingly similar design to the one it has developed over many years in Australia. They considered this misleading and deceptive conduct, and a breach of their intellectual property rights which could affect their ability to establish their business here. The Court agreed.
Muzz Buzz has numerous franchised drive-through coffee businesses in Australia and launched into New Zealand in 2013.
Prior to Muzz Buzz opening its first store here, a New Zealand couple had set-up a drive-through coffee business on Auckland’s North Shore called Jitta Buzz. This used a strikingly similar image to that used for many years by Muzz Buzz in Western Australia including fonts, colours, kiosk designs, etc. A second Jitta Buzz outlet was established in Botany Downs (Auckland).
Muzz Buzz claimed that Jitta Buzz was a copy of its model and intellectual property.
The Issue & The Law
There were several causes of action pleaded by Muzz Buzz against Jitta Buzz and its directors, including a breach of Muzz Buzz’s trademark, passing off of Muzz Buzz’s intellectual property in the design features of their outlets and materials, and misleading and deceptive conduct.
The Court had to determine whether or not Jitta Buzz copied Muzz Buzz’s image and whether it marketed itself in such a way as to pass off Jitta Buzz outlets as Muzz Buzz outlets – with the effect of confusing consumers into believing that Jitta Buzz and Muzz Buzz were one and the same.
The evidence showing that Jitta Buzz had indeed copied Muzz Buzz was so clear to the Court that the Judge said: I was led to the firm conclusion that when they were establishing their business, the defendants saw what they believed was an opportunity to capitalise on the success of the Muzz Buzz brand in Western Australia. I am satisfied that they decided to appropriate it to themselves for use in New Zealand by copying the essential elements of the brand, while stopping short of creating complete identicality, in the belief that being the first to brand drive-through coffee outlets in New Zealand in that manner entitled them to do so.
Muzz Buzz won and obtained a permanent injunction preventing Jitta Buzz and its directors from using the words Jitta Buzz or any similar name, and from displaying or otherwise using any text or images that are similar in appearance to text and images used by Muzz Buzz.
Be sure to come up with your own designs, look and feel and ensure that you investigate with the Intellectual Property Office and via internet search that you are not infringing someone else’s intellectual property before you brand your business and its assets. And franchisors: ensure you have properly registered your trademarks and other intellectual property.
The third case went all the way to the Court of Appeal before being resolved – a lengthy and expensive process for both parties. It hinged on issues of restraints of trade, breach of confidence and breach of copyright, although here we’ll focus on the first two elements only.
The defendant, Mrs McNeill, was a Safe Kids In Daily Supervision (SKIDS) master franchisee for a particular area. She assisted her daughter (who previously worked as an employee in one of Mrs McNeill’s SKIDS franchisee companies) in establishing a new company unconnected to SKIDS. The new company, Kids Choice Limited, operated an after-school childcare business from a site that was previously run by Mrs McNeill’s daughter as a SKIDS site. Mrs McNeill was a 50 percent shareholder in the new company.
The High Court ruled that because the level of knowledge and expertise required to run an after-school childcare programme was minimal, the restraint of trade in the SKIDS franchise agreement should not apply to Mrs McNeill. In short, its view was that the franchisor did not have a reasonable interest to protect because of the type of business being carried out by the franchisees and the relatively low barriers to entry into such a business.
The franchisor appealed the decision on several grounds, including a claim that the restraint of trade claim against Mrs McNeill should be enforced and a claim for damages owing to Mrs McNeill’s copying of SKIDS materials that were used by the new company. The intention in respect to the restraint issue was to prevent her and Kids Choice Limited from operating the competing business.
The Issue & The Law
In respect to the claim for the restraint of trade to be enforceable against Mrs McNeill, the Court of Appeal, in contradiction to the High Court, found that the franchisor did have reasonable interests to protect owing to the work they put into developing the system and the materials used by franchisees.
The High Court had earlier found that even if it had accepted that the restraint of trade was enforceable, it considered that the restraint period of two years was excessive and concluded that the appropriate restraint period would have to be three months. In this particular situation, the restraint period had expired and the Court of Appeal did not need to then examine whether the restraint period and radius were acceptable. They did, however, make the observation that, in their view, the restraint in the franchise agreement of 15km from any other SKIDS operation was possibly excessive and they would expect a radius akin to a reasonable area surrounding the franchisee’s area would be more appropriate. They also agreed with the High Court that a period of three months (albeit noted as being the bare minimum) was an appropriate restraint period.
In respect to the breach of confidence by Mrs McNeill of using SKIDS documentation to assist the new company in setting up its operations, the Court of Appeal found that Mrs McNeill did owe a duty of confidence in respect to those documents and that she breached that duty. The Court said that the materials took time to prepare and they did have a quality of confidence to them that should have been observed by Mrs McNeill.
Mrs McNeill and the new company were collectively ordered to pay damages to the franchisor of $22,000 owing to the breach of confidence by Mrs McNeill in unlawfully using the SKIDS material to assist the new company and, in respect of the new company, for it using that material knowing it to have been obtained without authorisation from the franchisor.
There is recognition by the Courts that where a franchisor has spent time and effort in creating systems and documents for its franchise system, those rights should be protected. No matter the type of work a franchise system may carry out, a restraint of trade against an outgoing franchisee will be enforceable if it is reasonable.
This article was first published in Franchise New Zealand magazine Year 23 Issue 01
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