There are no franchise-specific laws in New Zealand. However, as you would expect, existing laws protect franchisees, the main three being the Fair Trading Act 1986, the Commerce Act 1986 and the Contract and Commercial Law Act 2017.
There is no legal definition of ‘franchise’ but the rules of the Franchise Association of New Zealand define franchise as: “The method of conducting business under which the right to engage in the offering, selling or distributing of goods or services within New Zealand includes or is subject to at least the following features:
- The grant by a franchisor to a franchisee of the right to the use of a mark, in such a manner that the business carried on by the franchisee is or is capable of being identified by the public has been substantially associated with a mark identifying, commonly connected with or controlled by the franchisor; and
- The requirement that the franchisee conducts the business or that part of the business subject to the franchise agreement, in accordance with the marketing, business or technical plan or system specified by the franchisor; and
- The provision by the franchisor of ongoing marketing, business or technical assistance during the term of the franchise agreement.”
Restraint of trade
During the term of the franchise agreement, a franchisee is normally prevented from carrying on any competing business and may also be prevented from carrying on any other business, as his or her full-time attention is critical to the success of the franchise business.
The franchise agreement will also almost invariably contain a restraint of trade that will apply to the franchisee following the termination or expiration of the agreement or the sale of the franchise business to a third party. The length and area provisions of the restraint will normally be set out in a schedule and they will be subject to general legal principles governing restraints of trade.
The courts have recognised that it is reasonable for a person in the position of the franchisor to impose a contractual restraint upon any competitive conduct by a franchisee. Contractual restraints of this type are known as ‘restrictive covenants’ or ‘agreements in restraint of trade’.
Such agreements must not exceed the boundaries of the courts’ notion of reasonableness. There are two competing principles governing the courts’ decision-making process.
The first is that it is reasonable for a person to stipulate that if he or she is willing to disclose all secrets of how to establish a particular business enterprise, then the recipient of the information cannot immediately terminate the contract and set up a competitive business, using the information that it has received during the course of the educational process. If the courts did not provide protection to franchisors in such situations, there would be no incentive for the owners of established businesses to share their secrets with others and enhance their business skills.
The second principle is that it is important for the well-being of the community that every individual should, in general, be free to advance his or her skills and earning capacity. The way these two conflicting principles are resolved is to require that a restrictive covenant must be ‘reasonable’ in its terms before it will be enforced.
The current position in New Zealand is set out in s 83 of the Contract and Commercial Law Act 2017. It states as follows:
“(1) The court may, if a provision of a contract constitutes an unreasonable restraint of trade, –
- delete the provision and give effect to the contract as amended; or
- modify the provision so that, at the time the contract was entered into, the provision as modified would have been reasonable, and give effect to the contract as modified; or
- decline to enforce the contract if the deletion or modification of the provision would so alter the bargain between the parties that it would be unreasonable to allow the contract to stand.
(2) The court may modify a provision even if the modification cannot be effected by deleting words from the provision.”
What this means in practice is that if a franchise agreement provides for a three-year period of restraint when a two-year period would be considered reasonable, the covenant would be enforced to the extent that it could be rewritten by the court as being confined to a two-year term.
The ability of the courts to modify excessive restraints is constrained by the principle that terms that could never have been considered reasonable will not be modified. This is considered to be contrary to public interest that a person should be able to intimidate a contracting party by stipulating for a wholly unreasonable constraint and then have the court come to its rescue and rewrite the contract, so it falls within the boundaries of reasonableness.
What then is a reasonable restraint? There are two factors: area and time. For a franchise that teaches making coffee and running a café, an area of restraint would typically be confined to the area in which the franchisee is likely to establish goodwill. A person who establishes a café in Auckland is likely to establish goodwill that extends perhaps 200 to 400 metres from the site. There are so many other competing cafés that the goodwill would not extend much further than that.
The duration of a restrictive covenant should be such as will enable a franchisor to interpose a new operator who will have a reasonable time to secure the retention of the customers. In the case of a café, it is unlikely that this will extend beyond two years.
Cartels legislation
The Commerce (Cartels and Other Matters) Amendment Act 2017 is a recent amendment to the Commerce Act 1986. Key changes include the following.
Cartel conduct restrictions
The cartel conduct restrictions include the previous restrictions on competitors fixing prices as well as new restrictions on competitors jointly restricting output and market allocating.
Collaborative activity exemptions
This is a cartels exemption for permitted ‘collaborative activities’. Competitors can seek clearance for proposed collaborative activities if they give certainty that the proposed activities will not breach the Commerce Act.
Vertical supply contract exemption
This is an exemption for cartel provisions that are included in vertical supply contracts where certain requirements are met.
Because the cartels legislation impacts upon key areas contained in franchise agreements, it is important to explain the basis of a number of clauses that are commonly inserted in franchise agreements. Such clauses include approved products, approved services, restraint area, restraint period and location of a franchised operation.
As already stated, the restraint on competition clause is essential in any franchise agreement, but it must be carefully drafted so as not to infringe the Commerce (Cartels and Other Matters) Amendment Act 2017.
In relation to the restraint area, this should be defined as within a franchise or company-owned territory, for example, within 25 kilometres of a franchise or company-owned territory.
The purpose of the restraint area is to provide some protection to each franchisee and to encourage investment by all franchisees within the franchisor’s system, and also to provide some sort of protection to potential new members of the group.
The restraint period may be defined as one or two years and its purpose is to encourage investment by current and potential franchisees to build and operate their businesses. If any franchisee chooses to leave the group in the future, then the restraint period will provide some protection for the remaining franchisees.
Stewart Germann is a partner at Stewart Germann Law Office.
Next week Criminalisation of cartels and the case law.
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