As we discussed last week, while there are no franchise-specific laws in New Zealand, franchisees are protected by the Fair Trading Act 1986, the Commerce Act 1986 and the Contracts and Commercial Law Act 2017.
Consideration should also be given to the Commerce (Criminalisation of Cartels) Amendment Act 2019. This introduced a new criminal offence for cartel conduct and the proposed new criminal sanctions reflect the covert nature of cartels and the harm they cause to consumers and the economy.
The Commerce Act 1986 provides several statutory exceptions that would not constitute a cartel arrangement and may be pro-competitive. These exceptions relate to collaborative activities (eg, joint ventures or franchise arrangements), joint buying, vertical supply contracts and specified liner shipping arrangements.
There are no defences for mistakes of fact relating to the elements of joint buying and promotion and vertical supply contracts. Therefore, it would be possible in the future for a director of a franchisor company to be criminally liable under the Act for a cartel offence.
For an individual who commits an offence, the penalty on conviction could be imprisonment for a term not exceeding seven years or a fine not exceeding $500,000, or both. For a company that commits an offence, the penalty could be up to $10 million, so great care must be taken.
Cases relevant to franchising
Green Acres Franchise Group Limited v L & K Ferrick & Or [2021] NZHC 997
The plaintiff was the nationwide franchisor of the Green Acres System and the regional franchisee for Hawke’s Bay following the assignment of the master agreement on 4 February 2013.
L & K Ferrick was the subfranchisee in the Hawke’s Bay area. The directors were the guarantors although they never signed the agreement.
On 31 October 2020, the master agreement expired. A new agreement was not signed between the parties, but Ferrick continued to operate in accordance with the agreement. On 29 November 2020, the solicitors for Ferrick wrote to Green Acres alleging breaches of the agreement which were raised with the previous regional franchisee nine years earlier. The letter confirmed that the first defendant would not renew its franchise and would “cancel any residual holding over by the franchisee in relation to the now expired franchise agreement”.
Green Acres rejected the allegations and that the first defendant had grounds to cancel the agreement. It advised it would continue to perform the agreement and sought confirmation by the following day that Ferrick would also continue to perform the agreement. There was no response to this letter and on 3 December 2020 Green Acres cancelled the agreement, effective immediately. The solicitors advised of the application of clause 15 (consequences of termination which set out the obligation to return all intellectual property and all phone numbers used in the business – customer information) and clause 16 (restraint of trade for two years within New Zealand). There was no response to this letter.
Green Acres found out later that Ferrick had created a new company (New Ferrick Company) with the same directors and shareholders to Ferrick and put Ferrick into liquidation. The New Ferrick Company carried out the same work as the franchised business. Green Acres also engaged a private investigator who observed on 17 and 18 December 2020 Ferrick carrying out lawn and garden work at three separate areas in the Napier area.
Green Acres asked the liquidator to confirm that it held the customer information but the liquidator did not reply. Green Acres applied for an interim injunction, alleging breach of the restraint of trade, breach of confidence, interference with contractual relations and unlawful means conspiracy.
Green Acres argued that the director Ferrick had continued to service Green Acres clients in breach of the restraint clause, using the customer information which was the intellectual property of Green Acres and those obligations were reinforced by the confidentiality obligations in clauses 9.13 and 19.1(b) of the master agreement. Ferrick argued it was in liquidation and no longer trading, the terms relied on by Green Acres did not survive termination as there were previous disputes with the old regional franchisee, the information was not adequately identified and that the customer information was not the intellectual property of Green Acres.
The court found for Green Acres and said it was arguable that the defendants deliberately retained the customer information and refused to return it to Green Acres. Furthermore, the customer information was adequately identified and confidential. Green Acres wanted the restraint to apply only to Hawke’s Bay which was reasonable and only to Ferrick.
The court granted the interim injunction. Although a liquidator was appointed for the franchisee, the court allowed the proceedings to continue, saying it was uncertain as to what information the liquidator had and it had not been forthcoming about the requests that it held the information requested.
Water Babies International Limited v Williams & Ors [2020] NZHC 1289
The application was for an interim injunction against Kelly Williams, a former franchisee in Wellington, as the first respondent, Silvana Tizzoni as the second respondent and Coral and Aquamarine Limited as the third respondent.
In essence, the franchise agreement with Kelly Williams expired and was not renewed. However, she was devious and involved a relative, Silvana Tizzoni, and her company to operate a similar business in Wellington under the name of Swim Babies. There was extensive correspondence between Kelly Williams and Stewart Germann Law Office, and Water Babies UK instructed the issue of interim injunction proceedings.
The case was heard at the High Court at Wellington on 3 June 2020 and on 10 June. Justice Doogue delivered his judgment and issued an interim injunction restraining Kelly Williams from divulging confidential information and requiring written undertakings from Kelly Williams and Silvana Tizzoni.
Interestingly, the judge issued a minute two days later correcting some of the text of the orders that were initially incorrect. The case has been settled but the judgment confirms the importance of restraint on competition clauses in franchise agreements in New Zealand.
M and L Holdings (2012) Limited v Whenua Productions Limited & Anor [2020] NZHC 2541
The plaintiff was the area franchisee of a business that provided photography services to real estate agents to help market properties. The system is known as Open2view.
It granted the first defendant the right to operate a franchise in an area described in the agreement as Auckland South. The defendant decided to stop operating the business and when the plaintiff discovered the defendant had abandoned the business and was carrying on the same business under another name using the same customers in the territory, brought proceedings in the High Court seeking an injunction restraining the defendant from breaching the restraint of trade provisions, an account of profits, damages and costs.
No opposition was filed and the interim injunction was granted unopposed. The High Court expressed doubt that a restraint covering an area of 50 kilometres beyond the franchise area was a reasonable restraint but it accepted that its reasonableness was seriously arguable. The interim injunction extended to 50 kilometres. After the granting of the injunction, the lawyers negotiated a settlement that involved the defendant paying a sum of money to the plaintiff and also undertaking not to carry on a similar business within 50 kilometres of Auckland South.
Mad Butcher Holdings Limited v Standard 730 Limited & Ors [2019] NZHC 589
This case relates to the enforceability of restraint of trade clauses in relation to the Mad Butcher franchise system.
Standard 730 Limited, as the franchisee, had been a franchisee of the Mad Butcher franchise system at Whangarei since 1987 and the franchise agreement came to an end on 4 January 2019.
Mr Wightman of the franchisee initially indicated to Mad Butcher that he intended to set up a butcher’s training school. However, on 7 January 2019 he advised the franchisor that instead he would continue to trade as an independent butcher.
Wightman had by then arranged with the landlord to stay in the premises on a monthly tenancy after the lease expired.
After the franchisee commenced trading as an independent butcher, legal proceedings were filed seeking an interim injunction to restrain the franchisee from trading.
The franchisee argued that he was not in breach of the restraint of trade clause because there was no other Mad Butcher franchise store in the Whangarei area and that he was not in competition with the franchisor. He said the franchisor had no intention of establishing another Mad Butcher franchise in Whangarei and therefore there was no legitimate interest to protect in the Whangarei area.
Gault J found there was a strong argument that the plain meaning of the restraint of trade clause was that it applied regardless of whether there was an existing Mad Butcher franchise store in the designated area. The judge acknowledged there was some force in the franchisee’s alternative argument that the restraint could be unreasonable if the franchisor had no intention of competing or continuing business in the region.
The judge also dealt with the issue of whether, if the franchisee was able to establish a breach by the franchisor that would have justified cancellation of the franchise agreement, the franchisee would not be bound to perform the ongoing restraint. He accepted such a proposition was arguable and referred to Health Club Brands Limited v Colven [2013] NZHC 428.
Gault J concluded that his initial impression was that the franchisee would have an uphill battle establishing breaches by the franchisor sufficient to release the franchisee from performing ongoing obligations in the franchise agreement. He determined that the balance of convenience lay in favour of the franchisor, finding that damages would not necessarily be an adequate remedy for the franchisor.
The franchisee subsequently filed an application for leave to appeal the interlocutory judgment issued by Gault J to the Court of Appeal and for a stay. The application was opposed by Mad Butcher.
At the hearing, the judge gave his reasons in more detail for an interim injunction and then looked at the argument for leave to appeal. The judge said he was “conscious that I am being asked to review the correctness of my own decision . . . I must assess whether there is an arguable error . . . I have not identified an arguable error”.
The judge dismissed the application for leave to appeal and the previous orders were confirmed.
Data protection and data privacy
It is important for franchise parties to prevent data privacy violations. Both franchisors and franchisees will collect information pertaining to their employees, customers and suppliers.
Franchisees must evaluate the information and how to protect it. They should conduct data mapping – an internal audit process allowing the franchisee to determine what types of personal data it is receiving, where it is being stored, why it is being collected and how long the franchisee intends on keeping the data.
All of these processes must be set out in a privacy policy issued to customers and employees. The modern threat to this is the increased collection and use of personal information which is essential to the operation of all government and other agencies. Furthermore, with the advent of AI processing tools such as ChatGPT, franchisees must be careful of personal information being disseminated without that person’s consent.
In New Zealand, the right to privacy is a fundamental human right and is governed by the Privacy Act 2020. The Act endeavours to control by statute the four ethical issues involved, being privacy, accuracy, property and accessibility. The essence of the Privacy Act is the identification of 13 information privacy principles which were established by the OECD in Paris.
Franchisors must take an active role in protecting stored data and complying with regulations. In the event of a data breach or public violation of data privacy regulations, there will be a direct harm to the brand regardless of who is responsible for the violation.
Accordingly, franchisors must remain cautious of potentially non-compliant activities by franchisees. They must ensure all franchisees conduct their businesses to high standards to ensure compliance with the laws.
Franchisors can require written confirmation from franchisees that they have complied with any changes to data collection and data privacy laws and require that any changes will replace a current data protection plan. When a franchise ends, the covenant against competition should prevent a franchisee from stealing the data.
Conclusion
If you consider the cases discussed in this article, there is a trend to enforce restraint of trade provisions in favour of franchisors where there is a strong established brand. However, each restraint of trade scenario needs to be examined on its merits, and no one can assume that because there is a franchise system involved the restraint will be upheld.
The party attempting to enforce restraint must show that there is a proprietary or legitimate interest justifying the restraint, and that the restraint goes no wider than is reasonably necessary to protect that interest.
The decisions in the cases discussed, especially the recent Water Babies case and the Open2View case, will leave franchisors feeling confident about the enforceability of their restraints, but nothing is certain. The cases where the courts have been prepared to uphold restraints involve successful and well-established systems with strong brands, systems and a strong network of franchisees.
Therefore, in relation to interim injunction applications, the courts will recognise the need for enforceable restraints of trade to protect a franchisor’s goodwill.
Where the case is strong, the courts are willing to enforce a restraint of trade even where there will be significant cost and difficulty for the restrained party, and the remedies can even include forcing a restrained party to rejoin a franchise system it is in dispute with, pending the outcome of the trial.
Franchisees should consider the risks of the restraint being enforced before entering into or breaching restraints of trade.
Stewart Germann is a partner at the Stewart Germann Law Office.
Correction: A gremlin appears to have taken over page 12 of last week’s issue of LawNews and inserted a quote next to Stewart’s copy which has nothing whatsoever to do with what he wrote. LawNews regrets the error, apologies to Stewart and readers who may be been confused.
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