Non-compete clause too broad? – January 12, 2016 – mr. RCWL Albers

Franchisors have usually invested heavily in the development of their formula. It is therefore not surprising that franchisors try to protect their know-how by imposing restrictions on franchisees. One of these restrictions concerns the post-contractual non-compete clause that prohibits the franchisee from operating a business competing with the franchisor or its franchisees after the termination of the franchise agreement. 

It is common practice to limit the non-compete clause to one year after the end of the franchise agreement and to competition from or in a location or territory. However, there are also numerous formulas with (much) more far-reaching non-compete clauses. Both franchisees and franchisees regularly question whether and to what extent these restrictions are permissible, it being generally assumed that a non-compete clause should in all cases not extend beyond the aforementioned year after the end and the point of establishment or territory. However, this assumption rests on a misconception.

The admissibility of a non-compete clause is not clear-cut and strongly depends on the circumstances of the case, which are subject to change. Nevertheless, a number of tools can be distinguished on the basis of which the admissibility of a non-compete clause can be tested. 

In the much-cited Pronuptia judgment of the Court of Justice, the Court ruled that clauses to protect know-how are permitted in franchise relationships. After all, according to the court, the franchisor must be able to transfer his know-how to the franchisee without running the risk that this know-how, albeit indirectly, will benefit competitors.

To assess whether a non-compete clause is permissible under competition law, the Block Exemption Regulation on Vertical Agreements (hereinafter: GVO) can be used. For exemption from the cartel prohibition, the GVO prescribes that the clause is limited to (a) competitive goods or services and (b) the space and land where the franchisee has been operating during the contract period. It also serves (c) be indispensable to protect the transferred know-how and (d) be limited in duration to the period of one year after the end of the franchise agreement. 

Various franchisors have adhered to these criteria when formulating their non-compete clause, however, it is often wrongly assumed that deviations from this are by definition contrary to the Competition Act and result in a null and void non-compete clause. A non-compete clause extending beyond a franchisee’s place of business or territory may be permissible provided that such clause does not lead to an appreciable distortion of competition in the relevant market. If, for example, due to the weak position of the parties involved in the relevant market, this is not the case, this will not lead to a conflict with the Competition Act. For the assessment of brandability, the relevant geographic and product market must be defined. It would go too far to elaborate on the determination of the appreciability here, but it is advisable to seek advice on this in case of doubt about the admissibility of the non-compete clause. 

Please note that appreciability is only relevant to assess whether a non-compete clause is permitted under competition law. A (very) far-reaching non-compete clause could also be set aside by a court on other grounds if a franchisee objects to it. For example, a franchisee could invoke the fact that the clause is unreasonably onerous for him or unacceptable according to standards of reasonableness and fairness. A court will assess such appeals by a franchisee through a balancing of interests that takes into account all the circumstances of the case. In principle, what has been agreed applies, but circumstances may arise in which the court rules that it is unreasonable to hold a franchisee to a non-compete clause. This weighing of interests may be in favor of the franchisee if the non-compete clause is formulated too broadly.  

In summary, it can be concluded that a non-compete clause is a lawful means of protecting the know-how of a franchisor and that under certain circumstances the formulation of a non-compete clause may deviate from the criteria included in the GO. However, in the event of a deviation from this by broadening a non-compete clause, a well-considered risk assessment is appropriate for franchisors.

mr. RCWL Albers – Franchise Attorney
Ludwig & Van Dam Franchise attorneys, franchise legal advice. Do you want to respond? Go to albers@ludwigvandam.nl