Some thoughts on non-competition clauses in franchise agreements

The case. 

I have recently renewed my membership in my gym in Madrid. It belonged to a well-known franchise network but, surprisingly, when I came to pay my subscription there was a difference: same premises, same employees, same company, but different brand. The manager explained to me that they decided not to renew the franchise agreement but just to change the name and keep the clients.

The problem. When I was training, my brain was thinking about the situation and then I realized about the importance of “non-competition” clauses, and the possibility of goodwill compensation in franchise agreements. Then I decided to write this post.

 

My thoughts.

As we know, in a franchise agreement franchisees receive the know-how of the franchisor (a business model) and pay royalties in exchange. The know-how includes the possibility to use the trademark together with other elements necessary for the operating of the business. With all these elements, Franchisees usually get the opportunity to easily enter in a determinate market with controlled expenses and with the support and assistance of the Franchisor. The problem, in fact, can arise after the expiration of the franchise agreement: can the Franchisee continue with a different brand but exactly for the same business and in the same place? Can Franchisee or Franchisor ask for clientele compensation to the other party?

Under Spanish law, it will be possible to include a non-competition clause avoiding Franchisee to continue with the same or competitor activities in the same premises after the termination of the agreement. In fact, these clauses are quite common: in their absence it would be quite easy for the Franchisee (as my gym did) to just change the logo and external appearance of the premises and to still benefit the whole clientele. With the non-competition clauses the Franchisor will have the opportunity to re-open the activity within the same area or region with a new Franchisee and without the competition of the old Franchisee.

Would it be possible to claim for a goodwill compensation (clientele) in case of termination of the agreement? And if so, who will be entitled to ask for it? The question arises considering the goodwill indemnity existing in the Spanish legislation (as well as other EU jurisdiction implementing the EU Directive on Commercial Agents) in case of termination of the Agency agreements. In general terms, Agents will be entitled to receive a goodwill compensation for the clientele created to the Principal. In Spain, due to the analogical application of the Agency Act to Distribution agreements, the goodwill compensation has also been granted to Distributors for the clientele created to the Providers. Could this also be applicable in case of Franchise agreements? But what happen if the clientele benefits not the Franchisor but the Franchisee like in the case of my gym?

 

The possible solution.

The solution is not evident: first, because the acceptance of the goodwill indemnity is not unanimous in franchise agreements and, second, because courts have not examined the goodwill compensation in favor of Franchisors but Franchisees.

Some courts have accepted the exclusion of the goodwill indemnity by the parties in the agreement, but others have considered (by analogy with the Agency regulations) that the goodwill compensation remunerates the benefits the clientele is producing in the Franchisor and, for that reason, it is not incompatible with the loss of profits indemnity (lucro cesante). Could these arguments be used by the Franchisor to ask the Franchisee a compensation for the clientele this one is still benefitting after the termination of the agreement?

The answer will be clearly “no” in case the agreement expressly excludes it. The law makes no provision on goodwill compensation in franchise agreements so parties are free to decide that no compensation will be due.

On the other hand, if the agreement permits the Franchisee to still operate in the market, or does not expressly avoid doing so, the solution could be different and not so evident. In these cases, in my opinion, no reason should exist to avoid the Franchisor to claim the goodwill compensation (or, at least, to carefully review the concrete situation in order to understand if it is possible or not), although it is not expressly mentioned in the law (and, of course, if the parties have expressly foreseen it in the agreement). Like in my gym, Franchisee will still benefit of the know-how and goodwill (including clientele) created as a consequence of its participation in a franchise network under the brand of the Franchisor so I see no reason to compensate the Franchisor -as we do with Agents or Franchisees- if the other party takes advantages of the termination. I am aware that the analogy could be complicated (we will need to justify the similarity with the Agency agreements and with the reason for such compensation, and also to consider that the beneficiary of the compensation has always been the Franchisee and not the Franchisor), but Franchisors should not exclude this possibility in a case-by-case basis.

 

My recommendation.

This said, my recommendation is not to let aside automatically the possibility of such goodwill compensation for the Franchisors in cases similar to my gym (or other service providers franchises), and, in any case, to take it into account when negotiating and drafting your franchise agreements.

Ignacio Alonso

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