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Franchise Non-Competition Agreements in California
Franchise agreements almost always have non-competition
covenants. [Non-competition covenants go by a number of
names, including “restrictive covenants” and “no-competes,”
but I’ll refer to them as non-competes.] A franchisor uses
a non-compete agreement to stop the franchisee from
competing against the franchisor.
To give you my conclusion up-front, CA law generally voids a
non-compete agreement, but permits the franchisor to use
trade secret protections to stop the franchisee’s unfair
competition.
California Law Generally Voids Non-Compete Agreements
The law of non-competes in California is simple on its face –
a contract by which one is
restrained from engaging in a lawful trade or business is to
that extent void (CA B&P §16600).
That is, a contract is void if it
prohibits one from engaging in a particular industry.
In-Term
and After-Termination Non-Competes
A non-compete can be effective during the term of a
franchise (“in-term”), and/or after termination of a
franchise (“after-termination”). CA law is slightly
different for in-term and after-termination non-competes.
In-Term. CA law on
in-term non-competes is as clear as mud. CA courts will
void an in-term non-compete in a franchise agreement if it
cuts off competition in a “substantial share of a business,
trade or market.” This is a fact-driven determination and
it is impossible to predict the outcome of any given case.
After-Termination.
Most non-compete cases occur after-termination when the
franchisee defaults on the franchise but tries to stay in
the industry on his own. CA law will void nearly every
non-compete that applies after termination of a franchise
relationship.
Your Contractual Choice-of-Law Doesn’t Help
Your franchise agreement likely has a choice-of-law
provision that requires use of your home state’s law.
Although CA is rarely the chosen law in the franchise
agreement, still, CA courts apply CA law to the non-compete
provision in the contract. That is, so long as the
franchisee operates in CA, CA courts generally use CA law
when deciding on the non-compete. CA courts protect CA
residents.
Don’t Be Too Aggressive
Franchisors frequently tell me they want the non-compete in
their franchise agreement to scare the franchisee, even
though the franchisor knows it’s unenforceable. This is not
smart. CA courts have permitted punitive damages against
companies that are overly aggressive in their use of
non-competes.
The Big Backdoor - Trade Secrets
When your non-compete fails, use trade secret law for
protection. Even though CA courts void non-competes, they
protect trade secrets. Franchisors can use trade secret law
to stop the franchisee’s unfair competition, that is,
prevent the franchisee from using your business methods and
other secret information to compete against the franchise
system.
A trade secret is information that is secret and that has
competitive value. Any information can be a trade secret so
long as it meets these two requirements – secrecy and
value. The formula for Coca-Cola is the classic example of
a trade secret. Other information can be a trade secret
too, for example, a customer list. A customer list can be a
trade secret if the information is not easily obtained from
public sources (e.g. a phone book) and contains valuable
information developed through effort and expense (such as
customer preferences and purchasing tendencies).
If your franchisee plans to compete against the franchise,
he might use your trade secrets to do so. It might be hard
for the franchisee to start over completely from scratch.
This is especially true if you taught the franchisee how to
do business in the first place or you introduced the
franchisee to all the important contacts in the industry.
CA law will stop the franchisee from using your trade
secrets against you. This in turn will help prevent the
franchisee from unfairly competing against you.
Shameless Plug
I’ve tried to make this article as simple as possible.
California law on non-competes and trade secret protection
is very complex, however. You need a competent franchise
attorney to help you.
If you want
to read more about franchising, try my main page
Franchise
Attorney. From there you can link to other
pages and articles of interest.
Call
me to schedule a legal consultation:
510-796-9144
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