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A lesson in exercising restraint: when you can stop a rival from competing

1 September 2014

It's common practice for management teams and business owners to ensure that when they do business with potential competitors, such as in a franchise arrangement, they protect their commercial position with a suitable restriction on the franchisee. 

This has the aim of preventing it from taking the business's goodwill, skills and know-how (and potentially even staff) and using these to start their own competing operation straight after the initial venture has ended.

Non-competition clauses, which restrict the parties from operating rival businesses to one another, and non-solicitation clauses, whereby the parties cannot solicit the other's customers and employees, are the classic contractual mechanisms for achieving this form of commercial protection.

Competition law imposes limits on the scope and duration of the restrictions parties can agree.

Broadly speaking, if a clause looks to restrict the other party for a longer period and across a larger geographical territory than is deemed necessary to make the commercial agreement work, then it will not be enforceable.

Testing the concept: Carewatch Care Services v Focus Caring Services

The limits imposed by Chapter I of the Competition Act 1998 ("Chapter I") were tested in the High Court when Carewatch Care Services Limited ("Carewatch"), the UK's second largest provider of home care services, applied for an injunction to enforce non-competition terms in a franchise agreement with Focus Caring Services Limited ("Focus"). 

This agreement was terminated by notice from Focus in February 2014, but Carewatch wished to enforce the non-compete terms because Focus had set up a rival care operation in the East Anglia region, in breach of these commitments. 

Carewatch applied for an injunction, which Focus opposed on the basis that the non-compete restrictions were unenforceable as they failed to comply with Chapter I. 

The scope of what is reasonable

The High Court was willing to recognise the purpose behind the non-compete restrictions in this case, being to protect Carewatch's goodwill for a 12-month period after termination or expiry of the franchise agreement with Focus. 

Focus argued that this was an unlawful restriction on competition. 

However, Carewatch successfully pointed to the rulings in two EU cases (Case 161/84 Pronuptia and 88/604/EEC ServiceMaster), in arguing that the scope of the restrictions was limited to what was strictly necessary to ensure the know-how and assistance it provided to Focus under the franchise agreement did not directly benefit competitors in the short run. 

The ServiceMaster ruling, in particular, emphasised the importance of this protection for franchises concerning the provision of services as opposed to simpler distribution-type franchises. 

A major reason for this is the close relationship that is built up between providers and receivers of services, meaning that if a franchise party is allowed to take the specific know-how relating to each customer relationship away after termination of the agreement, its former franchise partner will have lost out directly. 

The Court emphasised that whether the need to protect against this scenario warrants the relevant scope of restriction in the context of the agreement in question should be assessed on a case-by-case basis. 

In Carewatch's case, the High Court agreed that the 12 month non-competition and non-solicitation clauses were justified in the circumstances and so should be enforceable against Focus. 

The assistance and know-how Carewatch had provided had already enabled Focus to grow from scratch to a successful home care operation within the space of 15 years. 

It was clear that it could become a serious competitor to Carewatch if it were allowed to set up an unauthorised rival business during the term of the non-compete provision. 

In effect, therefore, the Court concluded that, given the nature of the business in question, it was reasonable for an operator in Carewatch's line of business to insist on post-termination protection. It was therefore entitled to be granted an injunction to enforce this.

So, don't be afraid to ask for non-compete protection… but always seek advice first!

The overriding message to emerge from the Carewatch ruling is that post-termination non-competition and non-solicitation clauses are appropriate in some circumstances, particularly where one party is being given a franchise to perform a service. 

Provided the term does not last for more than one year and does not cover an excessively large area, it may well be enforceable. 

Competition law may fundamentally be about promoting contestable markets, but it also recognises that without scope for some contractual protection, ventures such as franchising, R&D and 'commercialisation' may dwindle. 

In many cases, if there is no scope for protection, the commercial risk begins to outweigh the commercial benefit for business owners in entering into them.

As such, it pays to always seek expert advice on whether a possible non-compete and/or non-solicitation clause might be acceptable before the UK and EU courts.

This article was written by Rory Ashmore.

For more information please contact Rory on +44 (0)20 7427 1031 or rory.ashmore@crsblaw.com