Franchisors often present these clauses as standard protections for their business. However, in New South Wales, restraint clauses are not automatically enforceable simply because they appear in a signed contract. Courts will only uphold and enforce a restraint to the extent that it is reasonably necessary to protect a franchisor’s legitimate business interests.
This approach was demonstrated in Narellan Franchise Pty Ltd v RBME Pty Ltd (No 2) [2022] NSWSC 1590, a decision upheld on appeal in Narellan Franchise Pty Ltd v RBME Pty Ltd[2023] NSWCA 139, where our firm appeared for a former franchisee who succeeded in having a restraint clause declared invalid.
The Starting Position: Restraints of Trade are presumptively void
Australian courts have long treated restraints of trade with caution. While they are regulated to some extent nationwide through the Competition and Consumer Act 2010 (Cth), New South Wales is the only jurisdiction that has its own legislation dealing with restraint of trade clauses, enshrined in the Restraints of Trade Act 1976 (NSW) (Act).
The starting position is that contractual restraints are contrary to public policy; indeed, they are only valid to the extent they are not contrary to public policy: s 4 of the Act. There is a clear rationale at play here: restraints interfere with a person’s, or business’ ability to earn a living and compete freely in the marketplace.
That does not mean restraints are always unenforceable. Rather, the party seeking to enforce the restraint (usually the franchisor) bears the burden of proving that the restraint is reasonable and goes no further than reasonably necessary to protect their legitimate interests: McHugh v Australia Jockey Club Ltd [2014] FCAFC 45; 314 ALR 20 at [4].
In this vein, the Act allows courts to “read down” restraint clauses to make them reasonable, on such terms the Court deems fit, rather than invalidating them entirely: s 4(3) of the Act. This gives NSW courts greater flexibility than courts in some other jurisdictions. However, the legislation does not give franchisors a free pass. A restraint must still be reasonable in all the circumstances.
What Is a “Legitimate Interest”?
A restraint against mere competition is unenforceable: Amoco Australia Pty Ltd v Rocca Bros Motor Engineering Co Pty Ltd at 295; Tullett Prebon (Australia) Pty Ltd v Purcell (2008) 175 IR 414; [2008] NSWSC 852 at [47]; Koops Martin Financial Services Pty Ltd v Reeves [2006] NSWSC 449 at [30].
The categories of legitimate interests that may justify the imposition of a restraint may include:- protection of confidential information, intellectual property and trade secrets;
- preservation of goodwill associated with the franchise system (which will generally need to be of a substantial value: Testel Australia Pty Ltd v KRG Electrics Pty Ltd [2013] SASC 91 at [54]);
- protection of customer relationships and connections developed through the franchise network; and
- maintenance of the integrity and stability of the franchise system.
Self-evidently, the extent to which these categories apply will vary depending on the specific circumstances of the matter. Importantly, the courts distinguish between protecting legitimate goodwill and simply preventing a former franchisee from using the skills, experience and business know-how they acquired while operating the business. The party benefiting from the restraint has the onus of showing the restraint is no more than what is reasonably necessary to protect its interests.
The Narellan Franchise Decision
The decision in Narellan Franchise Pty Ltd v RBME Pty Ltd (No 2) [2022] NSWSC 1590 (Primary Judgment) involved the well-known “Narellan Pools” franchise system, which specialises in fibreglass pool installation.
The Defendants had operated two Narellan Pools franchise territories in Sydney for approximately 14 years. When the franchise agreements came to an end in mid-2022, the former franchisees continued operating an in-ground pool installation business. The franchisor sought injunctions enforcing post-contractual restraints that would prevent the former franchisees from conducting a competing business within the franchise territories for a period of 12 months.
Initially, Narellan obtained urgent injunctive relief from the Supreme Court of New South Wales that restrained the former franchisees pending further order, which did not apply to the completion of contracts entered into with customers prior to the date of the orders: Narellan Franchise Pty Ltd v RBME Pty Ltd [2022] NSWSC 988. However, a mere four months later, following an expedited hearing, the Court refused to grant final injunctions enforcing the restraints and found the contractual restraints were invalid and unenforceable as unreasonable restraints of trade: Primary Judgment at [248].
Why the restraints failed
Central to the Primary Judgment was Parker J’s findings that Narellan had failed to prove it had a sufficient interest to justify the imposition of a restraint on competition against the former franchisee following the expiry of the Franchise Agreement: [199]. His Honour went further to find that, even if he was wrong about that issue and some period of protection from competition was required, that period had expired on the Plaintiffs’ own evidence: [210].
The Plaintiffs sought to establish their legitimate interest justifying the restraints in various ways; namely:
1. that they were necessary to protect the Plaintiffs’ goodwill in the franchise territories;
2. that they were necessary to allow incoming franchisees to establish themselves in the franchise territories (as, otherwise, the former franchisees would have a competitive advantage over an incoming franchisee in those territories);
3. that the franchisor had a proprietary interest in maintaining the flow of orders made by the franchisee to the supplier of pool shells (a related entity) that were installed by the franchisee; and
4. that it was necessary to protect the franchisor’s intellectual property and confidential information.
Parker J did not accept these arguments. In respect of each argument, he found that:
1. any experience the former franchisee gained, and any resulting personal reputation they had with customers, was the result of their own efforts and was not gained at the franchisor’s expense. Any “local goodwill” that accrued to the former franchisee (being the language adopted in the Franchise Agreement itself) is, by definition, something that the former franchisee retains after the agreement comes to an end and the franchisor’s “brand goodwill” is surrendered: [186]. In finding this, his Honour placed emphasis on the fact that it was very difficult to isolate the goodwill resulting from the period of the Franchise Agreement, as distinct from skills and experience that were innate or developed before it was entered into: [192];
2. the franchisor failed to adduce any proper and admissible evidence that it had failed to find a new franchisee due to concerns about competition from the former franchisees’ new business (to the extent that this evidence would be relevant): [195]-[198];
3. it was the supplier, not the franchisor, who generated the profits derived from the manufacture and sale of pool shells; the franchisor’s interest, rather, lay in the payment of franchise fees: [188]; and
4. other clauses in the Franchise Agreement, which remained in force, protected the franchisor against any misuse of its intellectual property and confidential information: [189]. This issue did not affect the reasonableness, or otherwise, of the restraint.
Another important aspect of the case involved customer contracts that had not yet been completed when the franchise relationship ended. The franchisor sought to restrain the former franchisees from dealing with those customers by reference to its “goodwill”, which purported to include the benefit of uncompleted customer contracts.
Again, the Court found that it would be unreasonable to impose a restraint in respect of these uncompleted contracts. The Franchise Agreement, quite surprisingly, was entirely silent as to what was to happen with those contracts, and did not contain any entitlement for those incomplete contracts to be transferred to the franchisor. His Honour found that commercial considerations, from the perspective of all parties, militated against any restraint being imposed in respect of those contracts and noted that the franchisor was in a strong position to, if it wished to, negotiate with those customers to reclaim their business: [223]-[224].
Ultimately, Parker J held that the restraints were invalid and unenforceable in full. The former franchisee was free to run its competing business in the franchise territories.
The Court of Appeal
The franchisor appealed the Primary Judgment in Narellan Franchise Pty Ltd v RBME Pty Ltd [2023] NSWCA 139.
The Court of Appeal dismissed the appeal as “incompetent” and refused leave to appeal in circumstances where:
1. the Primary Judgment was interlocutory in nature for the purposes of s 101(2)(e) of the Supreme Court Act 1970 (NSW), as pecuniary relief had not yet been determined: [16]-[18]; and
2. it would be inappropriate to issue injunctive relief in circumstances where the 12-month post-contractual restraint period had, by the time of the appeal hearing, expired and Narellan’s notice of appeal sought declarations that went beyond that which had been sought before the primary judge: [28]-[32].
Importantly, and self-evidently, the Court did not disturb Parker J’s reasoning in the Primary Judgment.
Lessons for Franchisees
The Narellan litigation demonstrates the circumstances in which a Court will, or will not, enforce post-contractual restraints in the franchise context. For franchisees (and franchisors), a few practical lessons emerge.
1. A restraint must be narrowly tailored
A post-contractual restraint must not go further than reasonably necessary to protect the franchisor’s legitimate interests. The duration, geographic area, and prohibited conduct must all be proportionate to the franchisor’s legitimate interests.
A restraint preventing a former franchisee from operating “any similar business” across a broad territory for an extended period may be vulnerable to challenge.
2. Franchisors cannot “own” your experience
One of the most significant aspects of Parker J’s reasoning is the recognition that franchisees develop their own expertise, skills, and reputation over time, particularly through their relationships with customers (which, from a legal perspective, may vary depending on the nature of the franchisee’s and franchisor’s contractual relationship with end customers).
A franchisor cannot prevent a former franchisee from earning a livelihood by using their industry knowledge and practical experience accumulated through years of work. This is particularly relevant where the franchisee brings pre-existing expertise into the business or substantially contributes to the goodwill they have developed for theirs and/or the franchisor’s benefit.
3. NSW courts can read down clauses – but only to a point
Many franchise agreements contain cascading restraint clauses with multiple alternative time periods and geographic areas. While the Act allows the Court to ‘read down’ restraint clauses accordingly, it will not rewrite a fundamentally unreasonable clause to rescue poor drafting. A franchisor must still demonstrate that the restraint being enforced is objectively reasonable in light of the principles set out above.
Key Takeaways
Restraint of trade clauses in franchise agreements are not automatically enforceable in New South Wales. The law requires a careful balancing exercise between:- the franchisor’s legitimate commercial interests; and - the franchisee’s right to earn a living, carry on business and engage in competitive activity.
The Narellan litigation reinforces that a restraint will only be enforceable to the extent it is reasonably necessary to protect legitimate interests such as goodwill, confidential information, and customer connections. Courts will not enforce restraints that simply seek to eliminate competition for the franchisor’s benefit.
If you have an agreement that contains post-contractual restraints, these cases illustrate that restraint clauses should not automatically be accepted at face value. The enforceability of any restraint will depend on its specific wording and the surrounding circumstances. As our success in this litigation illustrates, Watson Webb has a strong team of commercial lawyers and litigators who are able to assist you in considering the enforceability of restraints that you may be subject to.
Disclaimer
This article is provided for general information purposes only and does not constitute legal advice. It is not intended to address the specific circumstances of any individual, business or franchise and reliance should not be placed on it as a substitute for obtaining legal advice tailored to your particular situation.
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