by Stewart Germann and Khushbu Sundarji
last updated 11/10/2021
Rights & Wrongs
by Stewart Germann and Khushbu Sundarji
last updated 11/10/2021
June 2020 – Stewart Germann and Khushbu Sundarji review lessons from three recent cases involving well-known New Zealand franchises.
When you take up a franchise, there are usually clauses in the agreement which prevent you using what you learn as a franchisee from competing with the franchise for a reasonable period after you have left. Our annual review of recent cases explores how those clauses have applied when former franchisees have sought to continue operating or be employed in a similar business.
Many franchise agreements contain post-termination obligations that require a franchisee to assign the lease of the premises to the franchisor upon request – but what happens when a franchisee buys the premises first to try and escape its obligations? Foodstuffs North Island Limited v Ravla Trading Limited looked at one such case.
Ravla Trading Limited (“RTL”) was a Four Square franchisee in Gisborne. The parties entered into a franchise agreement in 2008 in which Mr Ravla was an approved operator and both Mr and Mrs Ravla were guarantors. The parties entered into a further agreement in 2017 where Mr Ravla was an approved operator and that agreement also included clauses prohibiting RTL from damaging the goodwill of Foodstuffs or being involved in a business that competed with Foodstuffs or the franchised business, with RTL needing the prior written approval of Foodstuffs to sell the franchised business. The agreement contained a right of first refusal for Foodstuffs to purchase the business and the termination clause stated that no party could terminate the agreement except as expressly provided in the agreement.
When the 2008 agreement was signed RTL held a lease of the premises. Without the knowledge of Foodstuffs, RTL purchased the building in 2016 and in July 2019 transferred the building into the Ravla Family Trust (“the Trust”).
In June 2019 RTL wrote to Foodstuffs, advising that Mr Ravla was ill, and Mrs Ravla was appointed to operate the business. However, she wanted to operate an independent grocery store and accordingly RTL suggested a termination date of 1 August 2019. Foodstuffs advised that it did not want to terminate the agreement and as RTL had no right to terminate it unilaterally, it had to sell the business to an approved purchaser. Alternatively, Foodstuffs was interested in taking the headlease and operating the store.
When Foodstuffs refused to consent to the proposal there was a period of silence from RTL during which time the ownership of the premises was transferred to the Trust.
The Issue and the Law
The case came before the High Court at Gisborne as an interim injunction application to restrain RTL and the Trust from taking any steps to transfer to any party the franchised business or any interest or right of possession in respect of the premises. Justice Ellis granted the injunction and was of the view that it was seriously arguable that RTL’s intention to transfer its business to some new entity was an anticipated breach of the agreement in that it was without the consent of Foodstuffs and without first offering it to Foodstuffs. The Judge also said that the transfer of the premises by RTL to the Trust was for the purpose of avoiding its obligations under the franchise agreement and the Trust itself was a sham insofar as the transfer of the premises was concerned.
Justice Ellis was of the view that there was little undue prejudice that might be suffered by RTL whereas, by contrast, Foodstuffs would suffer damage to the goodwill of its brand and its goodwill at the premises.
The case serves as a strong warning to franchisees that courts will be willing to investigate any sham arrangements where they have as their outcome the avoidance of contractual obligations under a franchise agreement. Any franchisee wishing to follow a similar course of action is advised to seek expert legal advice and explore other options.
Open 2 interpretation
Can a restraint of trade clause affect former franchisees who become employees of another company? A case involving the Open2View franchise looked at this issue. The case was Mainland Digital Marketing Limited v Willetts.
Willets and Nordek Myers (the defendants) were franchisees of Mainland Digital Marketing Limited (“MDM”). MDM provided visual media services to the real estate industry under the Open2View name, including photography, videography, floorplans and internet marketing services.
The defendants did not renew their franchise agreement in 2019 and, after the expiry of the agreement, were employed by Bayleys Real Estate (an MDM client). MDM sought an injunction against the defendants for breach of the restraint provisions in the franchise agreement. Their initial application was unsuccessful. The court did not make any finding as to the interpretation of the contract, but suggested that the parties apply to the court to determine whether the defendants’ employment with Bayleys breached clause 38.2 (being the relevant provision) and Appendix 1 of the franchise agreements.
The Issue and the Law
Under clause 38.2, the franchisee could not be involved in a business considered to be a market competitor or an imitation of the Franchised System or similar to the Franchised Business or Restraint Business. Appendix 1 contained a non-solicitation clause for the geographic location for business dealings in the same type of business (Real Estate Photography, Floor Plans, Sign Boards, and Real Estate Internet Marketing) for a period of 2 years from the date of termination. Restraint Business was defined in the agreement as “collectively and individually the Franchised Business, or a business operating in the Restraint Area that is the same or similar to the Franchised Business or each separate business or actively specified in the Schedule”. Franchised Business was defined as “the marketing and supplying to Clients real estate digital photography and the promotion of lead based real estate marketing services and other complimentary (sic) products and services”.
MDM argued the defendants breached clause 38.2 by providing real estate photography to Bayleys, a market competitor. Although the term ‘employees’ was not included in clause 38.2, ‘agents’ could cover this as the defendants were carrying out services as representatives or agents of Bayleys. The defendants argued that MDM was relying on goodwill as the relevant proprietary interest, but under the agreement goodwill belonged to the franchisee. The defendants were ‘greenfield franchisees’ and developed the goodwill themselves. Clause 38.2 was not meant to restrain all business but to restrain the franchisees from leading a business venture with a market competitor or imitation of the franchise system. Finally, ‘agent’ could not be extended to include employee.
They further argued that there was no breach as the business dealings had to be the same type of business as the franchised business, meaning relationships between businesses, not employees. Although Bayleys provided a photography service, it did not provide the same services as MDM.
The High Court was told the Willets and Myers and Open2view franchise agreement came to an end in March 2019 and that MDM owed the defendant $69,000. Courts frown on restraints of trade; they limit business activity and the wording of any restraint is closely examined. If there is any ambiguity, it is construed against the person seeking to enforce the restraint.
The court found that there was no breach of clause 38.2 as the clause did not exclude the defendants from working as employees. However, it found that Bayleys, which was carrying on a similar business, could be considered a market competitor. Restraint Business included “each separate business or activity specified in the Schedule” and meant that it could include only the provision of real estate photography. Franchised Business also included the specific business being undertaken by the photographer franchisees. Bayleys provided real estate photography services. There was no requirement that Bayleys had to provide that service exclusively to any other business activities.
The court found that Appendix 1 was breached. Solicitation did not have to be overt. It could also mean a presence and willingness to do business with another person. Bayleys announced to staff and clients that the defendants would be working for Bayleys and the defendants solicited vendors through their LinkedIn page. The court accepted that this was solicitation in the broadest sense. The court also stated that business dealing was not just a commercial relationship between businesses, but implied transactions where there would be monetary gain or potential monetary gain. Each time the defendants were asked to provide real estate photography for a Bayleys agent, they were indirectly facilitating a business dealing.
As to the balance of convenience argument in relation to the interim injunction application, Justice Ellis was of the view that there was little undue prejudice that might be suffered by RTL whereas, by contrast, Foodstuffs would suffer damage to the goodwill of its brand and its goodwill at the premises.
Justice Nation said that there was no wording in the sub-franchise agreements that clearly prohibited the defendants from providing photographic services as employees for a former Open2view client. Restraint wording indirectly prohibiting such employment would require a full trial so the High Court refused an interim injunction blocking their continued employment with Bayleys.
The case emphasises that the enforcement of restraints of trade clauses is not easy and each case depends on the particular facts.
Cutting up rough
The Mad Butcher has been involved in considerable litigation over recent years, normally relating to its enforcement of a breach of restraint on competition provision against a former franchisee. The case of Mad Butcher Holdings Limited v Standard 720 Limited is no different.
Mad Butcher Holdings Limited (“MBH”) is the franchisor for the Mad Butcher brand. Standard 730 Limited (“Standard”) was a Mad Butcher franchisee in Whangarei. The franchise agreement contained a restraint of trade provision for a period of 2 years within the restraint area. Prior to the expiry of the franchise agreement on 4 January 2019, Standard advised MBH that it wanted to set up a butchers training school. However, Standard then told MBH that it intended to set up as an independent butcher and it started trading on 28 January 2019. MBH sought injunctive relief alleging breach of restraint of trade by Standard.
Standard argued that the restraint was aimed at preventing competition with other Mad Butcher stores and because the closest store was at Albany and MBH had no intention and no reasonable prospect of establishing another store in Whangarei, it should not be concerned. Standard argued that MBH had no legitimate goodwill to protect and therefore the clause was unenforceable and it did not depend on whether there was an existing Mad Butcher store. MBH said that it wanted to establish another store in the area, but could not if Standard was operating and Standard was trading on the goodwill built up while it was a Mad Butcher franchisee.
Justice Gault in the High Court at Whangarei agreed with MBH and found that there was a strong argument that the plain meaning of the restraint of trade clause was that it applied whether or not there was an existing Mad Butcher franchised store in the designated area. The restraint covered a business similar to the franchised business and was reasonable.
The Judge agreed that MBH would have difficulty in securing a new franchisee in the area and the potential to transition customers had already been compromised. The court also acknowledged that other franchisees would see Standard breaching the terms of the franchise agreement and damages would not be enough. He said that MBH needed to take active steps to enforce its rights and the court noted that Standard put itself in this position by trading as an independent butcher, knowing the risk and being put on notice by MBH.
The case was subsequently appealed but the Judge found that the injunctive relief was still the correct decision.
This case again reinforces that restraint on competition and restraint on trade clauses in New Zealand are very important for franchisors, who should not hesitate to apply for injunctive relief where the circumstances warrant it.
Franchisees must realise that when they enter into franchise agreements which contain restraints of trade clauses then, when they leave the franchise system either voluntarily or because the franchise agreement has expired or has been terminated, franchisees cannot set up in competition with the franchisor unless it is expressly provided for in the franchise agreement.
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