Court rules against franchisor in dispute over enforceability of post-termination restrictive covenants
By Gordon Drakes, Partner, Fieldfisher
In May this year, in Dwyer (UK Franchising) Ltd v Fredbar Ltd and another, the High Court held that a 12-month post-termination restriction on the ability of the franchisee to carry on a business similar to that covered by the franchise agreement was unreasonable and unenforceable.
This case highlights that the enforceability of post-term restrictions in franchise agreements subject to English law depends on the specific circumstances surrounding each individual agreement. It also confirms that, while a 12-month post-termination restrictive covenant may be reasonable to protect a franchisor in some circumstances, this does not mean that such a restriction would necessarily be reasonable in different circumstances.
Facts Dwyer (UK Franchising) Ltd (Dwyer) is the franchisor of Drain Doctor, a substantial plumbing and drain repair services franchise. In October 2018, it entered into a franchise agreement (the Agreement) with Fredbar Limited (Fredbar), with Mr Bartlett as guarantor. Fredbar was run solely by Mr Bartlett, who had formed the company expressly for the purpose of becoming a Drain Doctor franchisee.
The Agreement granted Fredbar the exclusive right to trade within nine specified postcode areas in Cardiff (the Territory) for ten years. It also provided that for a period of one year after termination or expiry neither Fredbar nor Mr Bartlett were permitted (either directly or indirectly) to be “engaged concerned or interested in a business similar to or competitive with” the Drain Doctor business within;
(i) the Territory or
(ii) a radius of five miles from the Territory (the Restrictive Covenants).
In March 2020, Mr Bartlett raised with Dwyer the possibility of suspending the Agreement under the force majeure clause, citing the dramatic fall in business due to the coronavirus pandemic and the fact that he was required to self-isolate to protect his clinically vulnerable son.
Although Dwyer asserted that the force majeure clause did not apply because Drain Doctor was a key worker service, it did offer to wave Fredbar’s obligation to pay certain franchise fees while Mr Bartlett was self-isolating provided he undertook no work at all during this time.
The offer made it clear, however, that if Fredbar continued to trade, all fees due under the Agreement would have to be paid and, if they were not, Dwyer would terminate the Agreement for breach and sue for damages. After several weeks, Fredbar accepted the offer.
In July 2020, Mr Bartlett sent an email to Dwyer purporting to terminate the Agreement, citing various conduct by Dwyer, including misrepresentation, undue influence and breach of a contract. He also asserted that even if he were not entitled to terminate the Agreement, he no longer intended to be bound by its terms. Dwyer refuted all the allegations and invited Mr Bartlett to reconsider his position, warning that it would terminate the Agreement and sue for damages if he did not.
In August 2020, Dwyer terminated the Agreement and sought, amongst other things, damages for breach of the Agreement, as well as injunctive relief to restrain breach of the Restrictive Covenants. In addition to re-asserting its entitlement to terminate the Agreement, in its defence, Fredbar also argued that the Restrictive Covenants were unreasonable and, therefore, unenforceable.
Judgment Termination of the Agreement The High Court held that the Agreement had been terminated by Dwyer in August 2020.
It found that Dwyer had failed to comply with the force majeure clause and committed other repudiatory breaches of the Agreement, entitling Fredbar to terminate, but determined that Fredbar had affirmed the Agreement through Mr Bartlett’s conduct and acceptance of Dwyer’s offer.
This being the case, it was held that Fredbar and Mr Bartlett had no right to terminate the Agreement, Mr Bartlett’s email constituted a repudiatory breach, and the Agreement was terminated by Dwyer in August 2020 when it accepted that breach.
The Restrictive Covenants The High Court held that the Restrictive Covenants were unenforceable on the grounds they did not strike a reasonable balance between freedom to contract and freedom of trade, and were far more extensive than was required to provide reasonable protection.
It held that the first restriction would prevent both Fredbar and Mr Bartlett from engaging or being concerned in any plumbing or drainage business within the Territory without exception. This would mean that Fredbar could not act as a subcontractor and Mr Barltett could not be employed by a plumbing or drainage company, or use Fredbar as his service company for that purpose, even when such sub-contracting and/or employment would have no effect on Dwyer’s protected goodwill.
It found that the unreasonableness of this was obvious in the circumstances and must have been known to Dwyer at the time the Agreement was made, particularly as it was reasonably foreseeable at that time that the restriction would seriously increase the risk of Mr Bartlett being unemployed and facing mortgagee possession proceedings.
Dwyer knew that Mr Bartlett had invested all his savings in the franchise business and would have no other source of income (except his partner’s relatively small one) should the franchise business not succeed. In addition, the High Court noted that the restriction included an exception permitting a financial interest in a plumbing and/or drainage business that did not allow Fredbar or Mr Bartlett to influence the economic conduct of that business, and determined that, having recognised the reasonableness of such an exception, it was unreasonable not to extend it to permit them to be engaged and/or concerned in such a business.
The second restriction was held to be unreasonable because there would be no goodwill to protect within the extended area as Fredbar had not provided services in any part of it. The fact that Fredbar could be permitted to work outside the Territory in limited circumstances did not mean it would be reasonable to prohibit engagement, concern or interest outside the Territory regardless of whether or not any goodwill had been established there. The High Court asserted that this was particularly the case given that the Agreement expressly prohibited Fredbar from actively soliciting customers outside of the Territory.
In addition, the High Court set out the following further reasons why the Restrictive Covenants were unenforceable:
Dwyer knew that Mr Bartlett had no previous experience of plumbing and drainage work or of being a company director prior to signing the Agreement and that this lack of experience meant there was a risk that the average projections achieved by other Drain Doctor franchisees would not apply to the Territory and/or be achieved by Fredbar. Furthermore, prior to entering into the Agreement, Dwyer had formed the opinion that failure of Fredbar’s franchise business was foreseeable.
It would be wrong to draw a distinction between Fredbar and Mr Bartlett for the purposes of the Restrictive Covenants because Fredbar’s business would start as, and could remain in effect, a service company for Mr Bartlett, and Dwyer had understood this.
There was no evidence of any discussion or negotiation of the Restrictive Covenants to take into consideration the specific circumstances surrounding the Agreement. There was a total inequality of bargaining power between the parties, and the Agreement had to be accepted or rejected in its standard form without amendment.
There were no reciprocal restrictions applicable should Dwyer commit a repudiatory breach.
There was no provision for Dwyer to wave the Restrictive Covenants by written consent, either with or without a “not to be unreasonably withheld condition”.
The Restrictive Covenants failed to distinguish between terminations at an early stage of the Agreement and terminations towards the end of the ten-year term when the goodwill to be protected was likely to be substantially more valuable.
Although Fredbar would gain knowledge of the Drain Doctor business and the requirements of the services provided to customers during the Agreement, there were no trade secrets to be protected by the Restrictive Covenants. Furthermore, even if there were, they could have been better protected by more specific provisions, for example by restrictions against soliciting or acting for former customers.
Comment This case highlights the fact that the enforceability of post-term restrictions in franchise agreements subject to English law is highly fact dependant. It also underscores the dangers of thinking that a previous finding of enforceability in respect of a restriction in one agreement will afford protection to a similar restriction in a different agreement.
Franchisors seeking to protect their businesses and ensure that former franchisees do not unfairly take advantage of their goodwill can no longer assume that a restriction limited to 12-month post term will be enforceable. The detailed reasoning provided by the High Court in its judgement will, however, provide useful guidance on the factors that need to be taken into consideration.
The judgment also demonstrates the lengths to which a court will go to redress a balance where it determines that a significant disparity in the bargaining power of the parties has led to one being unfairly prejudiced.
In this case, a significant factor in the High Court’s determination was the fact that it judged Mr Barlett to be an inexperienced franchisee who had taken an enormous risk for himself and his family and had not received the support and understanding from Dwyer that he should have.
This case serves as a timely reminder that there is no such thing as a “standard form” post-term restriction. Restrictive covenants in franchise agreements need to be carefully drafted and tailored to their individual circumstances to ensure enforceability and avoid any inadvertent loss of protection.