Corporate and Commercial

Testing the Franchisor's Restraint

Posted 02 April 2024

Nolwazi Mngadi (Paralegal)

A restraint of trade clause usually stipulates that at the end of the contractual relationship, one of the parties may not compete with the other, usually for a specific period of time and in a specific geographical location.

In terms of our Constitution, South Africans have the right to be economically active, and the drafters restraint of trade provisions in a contract must be careful not to inadvertently infringe this fundamental right with strict or unreasonable terms. On the other hand, individuals and businesses also have the freedom to enter into contracts and are bound by the provisions thereof. By signing a contract, each party agrees that they understand its terms, agree to be bound by those terms, and will fulfil its obligations in terms of the agreement.

Franchising as a business model means an entrepreneur has established a successful business model which has become commercially valuable. The franchisor shares its business skills and know-how with franchisees, who take advantage of the system and goodwill to in turn operate their own successful businesses. This know-how, trade-secrets, trademarks and goodwill are known as the “protectable interest”. It’s what sets the franchisor apart, and what is safeguarded by the restraint clause.

So when the enforceability of restraint of trade in a franchise agreement is called into question, the courts test their validity by asking the following questions:

  • Is there actually a protectable interest?
  • Is the interest being prejudiced by the franchisee?
  • Is the restraint in the interests of public policy? In other words, the terms must not be harmful to the interests of the community or society.

A franchisor’s protectable interest is, in most cases, its intellectual property and know-how. When a franchisee purchases a franchise, it becomes part of the franchise network and the franchisor therefore has to safeguard its goodwill, not only for itself, but for the whole franchise network.

It’s important to keep in mind that general business training provided by a franchisor is not a protectable interest. The court in Kwik Kopy (SA) (Pty) Ltd v Van Haarlem found that the general training “geared to assist an inexperienced business person to set up a business and manage it” was not unique enough to constitute a protectable interest.

A restraint of trade clause in a franchise agreement must also be reasonable. In other words, the time and geographical location in the restraint must not be too onerous for the franchisee after the end of the contractual relationship. For example, a restraint of 10 years which encompasses the entire country would not be reasonable for a restaurant franchisee. This restraint would be against public policy because it would have the effect of preventing the franchisee from being economically active in that industry.

Franchisors whose main business is franchising must be wary of the wording of their restraint clauses. In Pam Golding Franchise Services (Pty) Ltd v Douglas, the restraint clause sought to prevent former franchisees from using Pam Golding’s trademarks and goodwill. The dispute arose when a former franchisee closed down its Pam Golding franchise and started a new estate agency under a new name. The court in this matter found that Pam Golding’s trade was actually that of franchising and not as an estate agent. The court held that the franchisor had no right to protect its potential subsequent franchisees against competition in general, and that the restraint was unreasonable, since its only purpose was to eliminate competition. This constituted an unjustifiable infringement of the former franchisee’s freedom to trade and was contrary to public policy. In short, it means that a franchisor cannot complain of competition if the franchisor is not itself competing with the ex-franchisee. In other words, unless the franchisor e.g. also owns and trades with its own corporate stores (and thereby competing with franchisees on an intra-brand level), a franchisor is not entitled to enforce a restraint against a previous franchisee. This is because the ex-franchisee does not actually compete against the non-operating franchisor. The ex-franchisee competes against the other existing franchisees, yes, but not the franchisor, who brought the application. This is the technical challenge faced by a non-trading franchisor.

It is crucial that a franchisor is able to describe the unique protectable interest being covered by the restraint of trade. Multiple court decisions have been handed down where franchisors’ restraint clauses were not upheld because the franchisors could not properly describe exactly what their protectable interest was. There must be enough information in a restraint of trade clause for a court to be able to establish the unique protectable interest – this can include special techniques or unique marketing methods. To avoid doubt, the drafter must specify these as accurately as possible, as well as what makes it unique to the franchisor’s business, and how the restraint gives the franchisor a competitive advantage. This way, franchisees acknowledge what those interests are when they enter into the agreement.

In Mozart Ice Cream Classic Franchises v Davidoff and Another, the franchisor alleged that the former franchisee used its customer connections, thereby contravening the restraint clause of the franchise agreement. The court found that customer connections are only protected by a restraint of trade clause when “knowledge of the needs of the customer, the way in which those needs are fulfilled by the party seeking to enforce the restraint and the identity of those within the customer’s organisation who are in a position to influence a movement of the custom to the person sought to be restrained.”

If a franchisee is taken to court for alleged breach of a restraint of trade clause, it is necessary to determine whether the franchisor is actually enforcing a legitimate protectable interest, and not merely looking to thin out the competition.