It is safe to say that nearly all franchise agreements contain a covenant against competition, or a non-compete clause. These clauses generally limit the activities a franchisee can engage in while he/she is a franchisee, and following the end of the franchise relationship. Courts (with the exception of California) generally enforce such restrictive covenants so long as they are reasonable in time and geographic scope and necessary to protect a franchisor’s “legitimate business interest.” Courts have found that a franchisor’s legitimate business interests can include trade secrets, valuable confidential business information, customer goodwill and specialized training received by the franchisee.
For a hypothetical fast-casual pizza chain, a restrictive covenant prohibiting a former franchisee from working in any food-service business for a period of twenty years after the termination or expiration of the franchise agreement anywhere in the United States would, in all likelihood, be deemed overbroad by most courts. However, a less onerous restrictive covenant, more likely to be enforced, may prohibit a franchisee from having any interest in a competitive pizza-making business for a period of two years after the termination or expiration of the franchise agreement within a ten mile radius from where the franchisee used to operate his franchised pizza business. Not only is this clause not as restrictive of a franchisee’s future activities, but there is a stronger argument that these restrictions are necessary to protect legitimate business interests.
Some states have laws on the books to guide a court in determining reasonable time or geographic limitations, or legitimate business interests. Lacking any specific law or statute, a court may look to prior decisions to aid it in determining similar issues. Accordingly, different state laws and case law mean it is entirely possible that a restrictive covenant in a franchise agreement could be enforceable in one state but determined to be overbroad and possibly unenforceable in another.
Franchise agreements typically include a provision specifying which state’s law will apply when questions concerning the franchise agreement arise. It is often where either the franchisor or the franchisee is located. However, courts will also generally look to the laws and public policy concerns of the state in which they are situated in determining whether to enforce a non-compete. For example, a franchisor might bring a lawsuit in California to enforce a non-compete clause against a California-based franchisee, pursuant to a franchisee agreement stating that New York law will apply to questions regarding the franchise agreement. Notwithstanding that New York law is specified, that California court would likely not enforce the non-compete clause because California’s laws generally deem them unenforceable.
As a franchisor seeking to draft or enforce a non-compete clause, or a franchisee seeking to contest one, the questions surrounding the restrictive covenant do not end with whether it will be enforceable as written. You also need to know what the court will likely do once it determines your restrictive covenant is overbroad. Generally, courts have three options, which vary by state. A court can: 1) rewrite the provision to make it fair to both sides; 2) “blue pencil” the provision by striking out only the overbroad parts and keeping the rest; or 3) “red pencil” the provision by deleting the entire restrictive covenant from the franchise agreement.
This simplified overview of determining if, and to what extent, your non-compete provision is enforceable should demonstrate that there is nothing simple about this question. Careful reading of your franchise agreement and the laws and case law of the home states of the franchisee, franchisor and the state specified in the franchise agreement are all required.