Shifts in the Enforceability of Franchise Non-Competes
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Shifts in the Enforceability of Franchise Non-Competes

Shifts in the Enforceability of Franchise Non-Competes

For decades, non-compete provisions in franchise agreements have been used to help protect a franchisor’s brand, customers, and trade secrets. These contractual provisions are typically designed to prevent a franchisee from engaging in business activities that directly compete with the franchisor for a set time frame in a limited geographic radius.

However, there has been a recent assault on non-compete agreements because of a growing concern among state legislatures and courts across the country over the effect these provisions have on employees and local communities. Several recent developments may cause courts to begin examining franchise non-competes with greater scrutiny and could create an environment where courts are less likely to enforce these provisions—which would have a significant impact on both franchisors and franchisees.

Historically, courts have recognized that franchisors have a “legitimate business interest” in preserving their brand, and that non-competes can be a proper means of protecting that interest.

In Jiffy Lube Int’l, Inc. v. Weiss Bros., a 1993 case, the Federal District Court for the District of New Jersey held that a post termination non-compete clause was enforceable, and that the former franchisee could not continue operating a store and profiting off the franchisor’s brand after the franchise relationship had ended. Likewise, in a federal Pennsylvania case 2 years later, another court found that the non-compete provisions in a franchise agreement protected the “franchisor’s name, ability, and the good will attached to that name,” which was a significant business interest that deserved protection.

On the other hand, courts have also refused to enforce these provisions broadly and declined to enforce franchise non-competes where doing so would not protect a “legitimate” interest. For example, in Maxon v. Franklin Traffic Serv., Inc., a 1999 case, the court refused to enforce a non-compete agreement that sought to prevent the former franchisee from engaging in any similar business for 5 years within 300 miles of the franchisor. Because this provision was overly broad it was found to be unenforceable. And in a case by Dunkin’ Donuts in 2018, a non-compete wasn’t enforced because there was no evidence that the franchisee’s new business had an impact on Dunkin Donuts’ sales, brand, or trade secrets.

A shifting landscape

Federal and state lawmakers have become increasingly concerned with the effect of non-compete clauses because they often impose an enormous burden on a former franchisee’s ability to make a living after the termination of the franchise relationship. Because non-compete provisions are designed to prevent the franchisee from engaging in a “competitive” or “similar” business, former franchisees subject to a non-compete may find themselves precluded from an entire market sector—which could be devastating since the franchisee likely spent years honing their business skills and expertise in that area.

Most recently, the FTC has proposed a new rule that would ban the use of non-compete agreements in all industries, but it is still uncertain if and when such a rule would go into effect. We are also seeing an uptick of discussions around non-competes play out in states across the nation.

Editor’s note: On January 8, 2023, the FTC published a proposed rule to ban non-compete clauses in employment agreements. Comments to the proposed rule are currently due on March 20, 2023 and may be submitted here.

In New Jersey, the attorney general has expressed concern that non-compete and non-poach provisions in franchise agreements can have a harmful effect on a lower-wage employee’s ability to find employment. While New Jersey and New York continue to enforce non-compete agreements in franchise agreements, courts will “blue pencil” or “rewrite” terms that are overly broad or that contain undue restrictions on the franchisee. This may become a more common practice among courts in light of the recent assault on these types of provisions. Alternatively, some states such as California, North Dakota, and Oklahoma, and the District of Columbia have already held that non-competes are either entirely or largely unenforceable.

As non-competes continue to come under fire at both the federal and state levels, it is expected that courts will begin paying close attention to whether there are legitimate business interests being protected by a non-compete.

To reduce potential liability, franchisors should ensure the language in these provisions is carefully crafted to minimize the risk that the provision is perceived as “overly broad” or “unenforceable.” Franchisees also need to pay close attention to shifting legislation around non-competes. Those subject to restrictions from a non-compete should conduct a survey of the law when opening a new business to determine if the provision is enforceable and how they could be affected. Even if it is enforceable, a franchisee subject to a restriction should be careful to make sure their new business venture falls within the permissible scope of the provision before moving forward.

Dylan R. Newton is an attorney in Archer’s Business Litigation Group in Hackensack, NJ and New York, NY. He represents clients in a variety of commercial litigation and business disputes, and has extensive experience handling complex commercial litigation matters. Reach him at dnewton@archerlaw.com or (201) 498-8518. Michael S. Horn is a partner at Archer in Hackensack, NJ and New York, NY. He specializes in general litigation with an emphasis on commercial litigation, UCC claims, contractual disputes, real estate litigation, products liability litigation, complex litigation, insurance coverage disputes, and environmental litigation. Reach him at mhorn@archerlaw.com and (201) 498-8529.

Published: March 2nd, 2023

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