• Linda Reneslāce

What about post-termination non-compete clauses in franchise agreements?

In my previous post you learned that generally non-compete obligations in agreements may not exceed the term of 5 years. However, there is an exception applicable to franchise agreements where the non-compete obligation may be in force throughout the whole term of the franchise agreement provided that it is necessary for the protection of substantial know-how.

But what about non-compete obligations invoked after the termination of the franchise agreement?

When the franchise agreement expires or is for some reason terminated franchisees may sometimes easily continue operating a similar business at the same location by using the same client base and gained know-how. Considering the fact that the franchise agreements may be terminated prematurely or the fact that franchise agreements are often entered into for a term of only 5 years, franchisors may be interested in including post‑termination non-compete obligations in franchise agreements.

Generally, EU competition law does not look very favourably to non-compete obligations imposed after the termination of the agreement. However, European Commission’s Vertical Block Exemption Regulation (VBER) provides an exception to this general rule. A post term non-compete obligation in a franchise agreement will be deemed in line with the EU competition laws provided that the following conditions are met:

  1. the non-compete is valid for the period of one year after termination of the agreement,

  2. it relates to goods or services that are subject to franchise agreement;

  3. it is limited to the specific physical premises from which the franchisee offered the goods or services for sale during the term of the franchise agreement;

  4. it is necessary to protect the know-how transferred by the franchisor to the franchisee.

Therefore if the post-termination non-compete obligation in your franchise agreement complies with the above conditions, it will be deemed compliant with the EU competition law. Of course provided that the general conditions set by VBER in relation to the size of the market shares of the parties are fulfilled.

Country specific requirements

Keep in mind that national laws may provide for additional requirements or limitations on non‑compete obligations applicable to franchisees. For example, according to the Latvian Commercial Law and without prejudice to the applicable competition law requirements, the franchisor must pay the franchisee a compensation for the time period of non-compete. The compensation may be refused only if the franchisor terminated the franchise agreement due to the threats to good reputation or due to such substantial reason, which was based on blameable action of the franchisee.

Latvian law does not establish any guidelines for the amount of compensation, however, it needs to be “reasonable” considering the possible effects of the non-compete, for example:

  • nature of the non-compete (e.g., it applies only to the specific physical location);

  • the nature of the competitive business;

  • term of the non-compete (1 year or less);

  • the profit that the franchisee will lose, if it needs to change the nature and location of its business.

The less restrictive are the effects of the non-compete on the franchisee, the smaller can be the compensation for the non-compete obligation. For example, if the lease agreement with the franchisee regarding the lease of the physical location will expire after the term of the franchise agreement and the franchisee will be unable to renew it, the effect of the non‑compete will be less restrictive.

What to remember?

Depending on your everyday involvement with competition law this may be a lot to take in. Therefore to sum up everything regarding non-compete clauses in franchise agreements, remember at least the following:

  1. non-compete obligations in franchise agreements can be in force for the whole term of the franchise agreement and for up to 1 year after its termination;

  2. non-compete obligations must be limited to what is strictly necessary;

  3. non-compete obligations must be in line with country specific requirements (if any).

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