Buying a Franchise: Check the Limits of Non-Compete Clauses

Buying a franchise in Indonesia can affect businesses you already own, not just the outlet you plan to open. This is because of non-compete clauses: provisions that restrict a franchisee’s involvement in certain businesses. Protecting business know-how and brand identity is important in franchising. Before signing a contract, however, make sure the limits are clear so that you do not inadvertently breach the agreement simply by keeping an existing business or investing elsewhere.

1. Understand the clause’s purpose and legal basis

A non-compete obligation is different from a duty of confidentiality. Confidentiality restricts the use or disclosure of information, such as recipes, operating manuals and marketing strategies. A non-compete clause restricts business activities or a person’s involvement in a business considered to be a competitor. A contract may contain both, but do not assume they have the same scope.

Indonesia specifically regulates franchising through Government Regulation No. 35 of 2024 on Franchising, which replaced Government Regulation No. 42 of 2007. It governs franchise operations under written agreements. Franchisors must also provide prospective franchisees with an offering prospectus at least 14 calendar days before the agreement is signed. Use this opportunity to request a draft contract and review the restrictions on business activities.

The validity of an agreement also depends on Article 1320 of the Indonesian Civil Code, which sets out the requirements for a valid agreement. Nor should you assume that every restriction in a franchise contract is automatically exempt from competition law. Guidelines issued by Indonesia’s Competition Commission (KPPU) under KPPU Regulation No. 6 of 2009 explain the exemption for franchise-related agreements in Article 50(b) of Law No. 5 of 1999. That exemption does not provide blanket protection for monopolistic practices or unfair business competition.

In other words, the mere inclusion of a clause in a contract does not settle the question of its validity. Seek legal advice based on the wording of the clause and your business circumstances.

2. Identify which activities count as competition

Start by looking for definitions of “competing business”, “similar business” and “direct or indirect involvement”. Apparently straightforward terms may cover a wider range of activities than you expect.

For example, a prospective drinks franchisee may already own a bakery that also sells coffee. A ban on operating “any other food and beverage business” could potentially affect the entire bakery, even though its main products are different. This illustrates a contractual risk; it does not mean that all such clauses are necessarily enforceable or prohibited.

Ask for written answers to the following questions:

• Is a competitor defined by its main products, customer groups, outlet concept or entire business category?
• Does the restriction cover online businesses and sales through online marketplaces?
• Does it include working as an employee or consultant, or being a passive shareholder?
• Are shareholdings through collective investment schemes also restricted?
• Is a geographical boundary specified, or does the restriction apply regardless of location?

Prepare a list of your business activities and investments before negotiating. Include indirect ownership interests and management roles. This will help your legal adviser assess how the clause affects your actual circumstances, rather than simply reviewing its wording in general terms.

3. Check who is bound and what exceptions apply

Check whether the restriction applies only to the franchisee’s business entity or also names owners, directors, employees, affiliated companies and family members. The inclusion of these parties needs careful review, particularly if they are not signing the agreement themselves.

Also distinguish between a restriction that binds you and a promise that you will ensure other people do not compete. The latter can create risks if you are asked to guarantee the conduct of parties you do not actually control. Do not agree to take on such an obligation before understanding its consequences.

For an existing business, propose a written exception in a schedule to the contract. Specify the business’s name, activities, location, ownership and any limits on expansion. A verbal assurance such as “your existing business is fine” is not enough to establish the scope of the consent.

If new activities require permission, agree on the procedure: the documents to submit, who has authority to decide, the response deadline and the form of approval. Do not treat a lack of response as consent unless that mechanism is clearly stated in the contract.

4. Assess the duration, penalties and financial impact

Mark when the restriction takes effect and when it ends. If restrictions continue after the franchise relationship ends, examine their duration, geographical scope and prohibited activities separately. Do not assume that an indefinite restriction is automatically valid or automatically unenforceable; seek specific advice.

Next, read the consequences of a breach. Is there provision for written notice, an opportunity to explain the circumstances or time to remedy a breach that can be put right? Does the contract allow penalties, claims for damages or other consequences to apply together? Ask for an explanation of the basis for these measures and how they would be applied.

Calculate the opportunity cost as well. If you must close an existing business or sell an investment, factor that impact into your decision to buy the franchise. The cost of buying is not just the money paid to the franchisor: it also includes the income or business opportunities you must give up.

Practical step: before signing, prepare a list of your businesses, highlight every restriction on business activities and make sure each exception is agreed in writing. Take on commitments you understand and can meet, rather than those that merely seem safe on the strength of verbal explanations.