The non-competition clause in the franchise agreement

The post-contractual non-compete clause in the franchise agreement is perhaps the most discussed clause in franchising. This is partly due to the tension between the scarcity of good locations on the one hand and the pursuit of maximum returns for the franchisees on the other. The non-competition clause therefore often gives rise to conflicts after the franchise agreement has expired. The court recently ruled that a franchisee who violated that clause had to close his shop on forfeiture of a penalty. That is a hard blow for the franchisee who may have thought that such a clause was not much. Below are a number of reflections on the scope of such a clause and its (im)possibilities.

First of all, the non-competition clause must be distinguished into a non-competition clause during and a non-competition clause after the franchise agreement has expired. I shall confine myself to discussing the latter clause. 

A post-contractual prohibition of non-competition cannot always be regarded as a so-called core clause. It can sometimes also be regarded as a general condition to which, in principle, the legal rules regarding general terms and conditions may therefore also apply. A general condition may not be unreasonably onerous. In such cases, on the basis of the unreasonably onerous character of such a clause, whether or not in combination with the other provisions of the franchise agreement, it could therefore be claimed to be voidable. All this depends on the nature and scope of the clause, as well as the interest to be protected.

Even if the clause is considered to be the core clause of the franchise agreement, it is still possible to claim moderation or outside due to circumstances. However, this is the exception and not the rule and furthermore strongly depends on the circumstances of the case. The starting point is that the non-competition clause remains valid and that the risk of the offender always rests with the offender.

However, depending on the market share of the franchise organization, competition law may also contain restrictions to a greater or lesser extent with regard to the legal validity of a non-competition clause. This is not always recognized in time. In principle, the Competition Act prohibits anti-competitive agreements, insofar as the size of those agreements on the relevant market actually have appreciable anti-competitive effects. The Competition Act itself makes European competition law applicable. The so-called Vertical Agreements Regulation stipulates that a non-competition clause must, in principle, be limited to the location from which the franchise operation has taken place. Moreover, the prohibition of non-competition may in principle not last longer than one year after the end of the franchise agreement. Finally, the clause must also be necessary to protect the franchisor’s know-how. Many of the post-contractual non-compete clauses currently in use do not meet the aforementioned criteria. This means that it is at least not certain in advance whether these stipulations can actually withstand the test of judicial criticism in certain cases. Other estimates are possible, partly depending on the market share.

Finally, seen in this light, it is worth mentioning that the Supreme Court ruled on 18 December 2018 that such a clause prohibited under competition law may in principle not be converted into a less far-reaching but legally valid clause. This is called “conversion”. The Supreme Court has considered that this competition law has a preventive character and such a character, barring exceptions, does not allow the lesser to remain valid if the agreed superior turns out to be legally invalid. With this, the Supreme Court has thus indicated that Franchisors themselves must include a well-considered arrangement in the franchise agreement in advance. With the sword of Damocles as the punishment that when crossing the borders there is a risk that no prohibition at all applies.

In order to avoid the risk that an overly strict prohibition can overshoot its purpose because it can be annulled in whole or in part or proves to be null and void, it is therefore recommended that such a clause is not made heavier in advance than is strictly necessary for the protection of the formula.
Because the legal options also depend on the individual circumstances, it is therefore important to obtain good advice in advance about the limits and restrictions, so that both parties are not subsequently confronted with an impossible situation of closing the company, or the unintentional loss of a good location, or out of misplaced fear of nullity an overly restrictive prohibition of competition corresponds.

Ludwig & Van Dam franchise attorneys, franchise legal advice