Buying a franchise: check the limits of the non-compete clause

A franchise network relies on protecting its shared concept and know-how. As a buyer, however, you should establish exactly how far the agreement’s non-compete clause extends. It may affect your existing business interests, side activities and ability to run a business after leaving the network. Assess the clause against your livelihood and future plans before signing, rather than waiting until a new business opportunity arises.

1. Establish who is bound and what counts as competition

A non-compete clause may apply to more than just the franchise business you are buying. The draft agreement may also require you to give a personal undertaking or restrict activities carried out through other companies you own. Check whether you are signing solely as a company representative or also making a personal commitment.

Ask the franchisor to specify what it means by competing activities. A simple reference to similar business activities may leave it unclear whether the restriction covers, for example, an online service, consultancy, employment or an investment in another company. What matters is the wording of the clause and the actual nature of the activity, not just the company’s registered business sector.

To help with your review, list your existing business interests and commitments:

• companies in which you are a shareholder, director or employee
• side activities and services you sell through your own company
• planned acquisitions or new business ventures
• investments where it is unclear whether the restriction would apply.

If the agreement mentions family members or other people close to you, establish what obligation it actually places on you. As a rule, an agreement does not bind a third party unless they have agreed to be bound. However, it may require you to ensure something over which you have no practical control. Have a lawyer review any wording of this kind.

2. Distinguish between restrictions during and after the agreement

During the agreement, a non-compete clause may be justified by the need to protect the network’s know-how and ensure that the franchisee focuses on the agreed business. Even so, ask why the proposed scope is necessary. Banning all other business ventures is different from restricting the operation of a directly competing concept.

A post-termination restriction needs a separate assessment. It may affect whether you can use your professional skills, premises or equipment in your next business. Establish, at a minimum, how long the restriction lasts, its geographical scope and which activities it prohibits. Also check whether the restricted period starts when the agreement ends or at some other point.

Ask whether the same restriction applies regardless of how the agreement ends. Expiry of a fixed term, a breach by the franchisee and a breach by the franchisor are different situations from a buyer’s perspective. Do not leave their consequences to broadly worded provisions.

Set out a practical test case: if the franchise relationship ended, could you take a job with a company offering similar services or start a business based on your professional expertise? Ask the franchisor for a written interpretation. If the answer matters to your buying decision, incorporate the clarification into the agreement itself or a signed schedule to it.

3. Understand the legal framework in Finland

Finland has no specific franchise legislation, statutory franchise agreement registration system or prescribed franchise disclosure document. This does not, however, mean that every non-compete restriction written into an agreement is automatically permissible.

Finland’s Competition Act and the applicable EU competition rules are particularly relevant when assessing a non-compete clause. Under certain conditions, the EU Vertical Block Exemption Regulation can provide a competition-law safe harbour for an agreement between businesses. Its application depends on several factors, however, and a clause cannot be judged permissible simply because it appears in a franchise agreement.

Equally, a clause that falls outside the block exemption is not automatically prohibited for that reason alone; it may require an individual assessment. A post-termination non-compete clause, in particular, should be reviewed by a lawyer with expertise in competition law.

Section 36 of Finland’s Contracts Act allows an unreasonable contractual term to be adjusted or set aside. This is not a guaranteed safety net for the buyer, however, as the assessment depends on the circumstances as a whole. Finland’s Unfair Business Practices Act also prohibits, among other things, the use of misleading statements in business.

The Finnish Franchising Association’s Code of Ethics is a form of self-regulation, not law. Find out whether the franchisor has committed to it and how it is reflected in the agreement. Nor should you assume that the compensation rules for non-compete clauses in employment contracts apply to a franchise agreement between businesses.

4. Negotiate clear exceptions and consequences

If you already have other business activities, ask for a specific written exception allowing them to continue. It should identify the company, describe its activities and set out any limits. A verbal assurance that the franchisor does not usually interfere with side activities provides less certainty than an agreed contractual provision.

Also check the procedure for requesting an exception. Who within the network decides whether to grant permission, what information must you provide and when will you receive an answer? If permission can be withdrawn, establish the grounds for withdrawal and the implications for investments already made.

The financial significance of a non-compete clause also depends on the consequences of a breach. Read the contractual penalty, damages provisions and any other sanctions together. Establish whether a penalty can be imposed repeatedly or become payable in addition to damages. Keep non-compete obligations separate from confidentiality: permission to continue running a business does not entitle you to use the network’s protected trade secrets.

Practical checklist: do not accept a non-compete clause whose effects you cannot explain in your own words. Before buying, confirm who it binds, what it prohibits, how long it lasts and what happens if you breach it. Record all important exceptions in the agreement.