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29 November 2016
In Rush Hair Limited v Gibson-Forbes the English High Court considered whether two restrictive covenants relating to non-solicitation and non-competition given by an individual seller of a hair salon franchise in a share purchase agreement were enforceable. The High Court found for the claimant franchisor.
The judgment serves as a useful and informative discussion on a number of legal principles, such as contractual interpretation, restraint of trade and the enforceability of restrictive covenants. Franchisors and franchisees should take note that in franchise re-sales, it may be possible to impose stronger restrictive covenants on the seller in the sale documentation than would otherwise be possible in the franchise agreement.
The defendant was a franchisee of hairdressing concept Rush Hair, having entered into a franchise agreement with the claimant in 2008. Under the franchise agreement, the claimant granted the defendant franchise rights to operate a Rush hairdressing salon in the town of Windsor.
In 2015 the parties agreed for the defendant to sell the business back to the claimant prior to the end of the term of the franchise agreement and entered into a share purchase agreement. Clause 7 of the agreement imposed two restrictive covenants on the defendant:
Following completion of the sale in July 2016, the defendant established a new company and opened another hairdressing salon in Windsor, and hired a key employee of the acquired business. As a result, the claimant brought an action against the defendant alleging a breach of both restrictive covenants.
In contesting the claim, the defendant argued that:
The non-solicitation restrictive covenant in the share purchase agreement was drafted narrowly and applied to the first defendant. The first defendant was a director and shareholder of the new company, which engaged the key employee of the acquired business as manager and chief stylist of the new salon. The claimant argued unsuccessfully that the first defendant could not use the new company as a device to get around the restrictive covenants. The judge held that the appointment by the new company of the first defendant as a consultant was not an abuse of corporate legal personality. However, the first defendant had acted as an agent on behalf of the new company when entering into the consultancy agreement and here the judge ruled that, as a matter of contractual construction, it was commercially sensible to give the restrictive covenant a broader meaning and have it apply to those acts of the first defendant, whether on her own behalf or as an agent for another. The previous long-term franchise relationship between the claimant and the first defendant was relevant; as was the fact that the first defendant would always run a business through the medium of a limited liability company and a narrow interpretation of the restrictive covenant would have rendered it toothless, which was clearly not what the parties intended.
The judge rejected a submission from the defendant that the key employee was not 'employed' by the new company because she was engaged as a consultant on a self-employed basis and rejected a further submission that the share purchase agreement was void for uncertainty because it did not define the 'Rush business'; it was clear what the parties meant by that term, given the purpose of the agreement.
Covenants in restraint of trade are prima facie unenforceable under English and EU law, unless it can be shown that they are intended to protect a legitimate purpose and that they extend no further than reasonably necessary to achieve that purpose. This case concerned a non-competition restrictive covenant in the context of a share purchase agreement and not a franchise agreement, albeit in relation to the sale of a franchise business.
In relation to the defendant's submission that the non-competition restrictive covenant was an unenforceable restraint of trade, the judge affirmed that the restrictive covenant was reasonable to protect the legitimate interests of the defendant. The judge emphasised the distinction between covenants given by an employee to his or her employer and covenants given by the seller of a business to a buyer. This rule was summarised in Cavendish Square Holdings BV v EL Makdessi  EWHC 3582 (Comm), in which it was held that there is more freedom of contract between buyer and seller than between master and servant, because it is in the public interest that the seller should be able to achieve a high price for what it has to sell. The court held that the claimant was entitled to protect what it was paying for: the goodwill in the acquired business. It was clear that the aim of the restrictive covenant was to prevent the first defendant from operating a competing business anywhere in Windsor. The claimant was entitled to take the view that Windsor was a small town and that it would incur significant loss if the first defendant established a competing business in any part of that town. The judge also held that the duration of the restrictive covenant did not go beyond what was reasonably to be regarded as necessary for the protection of the claimant's interests. The judge pointed out that the first defendant had been trading under the franchise agreement for more than five years, had achieved considerable success and had built up a good reputation. There would have been real loss of business to the claimant if the first defendant had opened a competing salon during the second year of the restrictive covenant. The judge held that the period was not out of keeping with those upheld in other vendor-purchase agreements and the fact that the franchise agreement did not contain a similar restrictive covenant was not a matter of great weight; nor was the inequality of bargaining power that existed between the parties when negotiating the share purchase agreement.
The High Court's judgment serves as a useful reminder to franchisees and franchisors that restrictive covenants in a franchise sale situation can be longer in duration and potentially broader in scope that those which are typically included in an English law franchise agreement. Restrictive covenants in English law franchise agreements must also be viewed through the prism of applicable competition law.
It is surprising that this case reached the courts, given the risky course of action taken by the former franchisee. Franchisors can take comfort from the approach taken by the court to the matter of contractual construction; despite some deficiencies in the relevant drafting, the judge focused on the bigger picture and what the parties intended, as opposed to the actual written word, and by applying commercial common sense found resoundingly in favour of the franchisor/purchaser.
Nevertheless, restrictive covenants are common in franchise, agency and distribution agreements and the contracts which regulate the sale of such businesses. They seek to protect goodwill and customer relationships by limiting the licensee's right to operate a competing business both during the term and after the termination or expiry of the agreement, and are vital in protecting the integrity of a brand's network. They need to be carefully drafted and regularly reviewed by an experienced lawyer to ensure their enforceability and avoid any inadvertent loss of protection.
For further information on this topic please contact Gordon Drakes or Tim Rickard at Fieldfisher by telephone (+44 20 7861 4000) or email (email@example.com or firstname.lastname@example.org). The Fieldfisher website can be accessed at www.fieldfisher.com.
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