Non-compete clauses in franchising: getting the scope right

When turning your existing business into a franchise network, you need to decide which competing activities could genuinely harm the relationship. A non-compete clause can protect the concept, but an overly broad restriction may limit a franchisee’s ability to earn a living and raise legal concerns. Start with what needs protecting, rather than a standard clause borrowed from another company’s agreement.

1. Define what you need to protect

Franchising is built on cooperation between independent business owners. Franchisees run their own businesses while belonging to a network with a shared concept. A franchisor’s wish to avoid competition is therefore not, in itself, a practical justification for every restriction.

Instead, identify the specific risks. Could a franchisee use the concept’s distinctive working methods in a separate business? Could the same premises, staff or sales channel be used to steer customers towards a competing offering? Distinguish these situations from cases where the business owner simply has other commercial interests.

Prepare a short briefing covering three points:

• The interest to be protected: the knowledge, investment or aspect of the relationship that needs protection.
• The conduct that creates the risk: the specific action that could harm that interest.
• The alternatives: whether confidentiality obligations, rules on brand use or clear operational commitments, for example, could be sufficient.

This briefing will help your lawyer assess the need for protection. It will also make the clause easier to explain to a prospective franchisee. A non-compete clause should not replace carefully considered provisions setting out what each party must actually contribute to the relationship.

2. Distinguish between restrictions during and after the agreement

A restriction during the term of the agreement and one that applies after it ends have different practical consequences. Treat them as two separate issues, even if they appear close together in the agreement.

During the agreement, the question might be whether the franchisee may run a similar concept alongside the franchise. Define what counts as a competing business. Focus on the offering and the customer needs it meets, rather than using sweeping wording covering every activity the franchisor might undertake in future.

After the agreement ends, each restriction needs particularly careful assessment. The franchisee may need to continue working and using their general professional skills and knowledge. The end of their right to use your brand does not mean that all similar business activities can be prohibited.

Make a separate list setting out the following limits:

• Which goods or services are covered?
• Which roles are covered: running a business, employment, consultancy or ownership?
• Which geographical area or premises are affected?
• How long will the restriction apply?
• Which individuals or companies are actually bound by the agreement?

Do not assume that owners or people connected to them are automatically bound by an agreement with the franchisee’s company. If personal undertakings are also being considered, their scope and validity need to be reviewed separately.

3. Let Swedish law guide the drafting

Sweden has no comprehensive franchise law governing every aspect of the relationship. It does, however, have the Act (2006:484) on Franchisors’ Duty to Provide Information. This requires franchisors to provide clear, understandable written information about the meaning of the agreement and other relevant circumstances well before the agreement is entered into.

Non-compete restrictions applying during or after the agreement are among the matters the Act expressly requires franchisors to disclose. Describe the restriction so that the prospective franchisee can understand its practical consequences. Do not merely refer to the existence of a non-compete clause in the draft agreement.

Compliance with the disclosure obligation does not, however, make the restriction itself valid. The clause must also be assessed under, among other legislation, the Swedish Contracts Act and applicable competition rules. Section 38 of the Contracts Act addresses undertakings that restrict competition and provides that an undertaking is not binding to the extent that it goes beyond what is reasonable. Rules on unfair contract terms may also be relevant.

The Swedish Competition Act and EU competition rules may also affect which restrictions are permissible. The assessment depends on how the clause is drafted and the circumstances of the relationship. Do not therefore treat any particular time limit as a blanket guarantee of legality. Have the clause reviewed by a lawyer with expertise in both franchising and competition law before using it.

4. Test the clause against real situations

Once you have a draft, test whether it provides clear answers in everyday situations. Suppose the franchisee already owns a small stake in another company, wants to offer a complementary service or later takes a job with a business whose customer base partly overlaps with yours. Which situations fall within the restriction, and is that really what you intend?

Also document how any exceptions will be handled. Who can approve them? Must approval be in writing? How will you ensure that similar situations are assessed consistently across the franchise network? Informal verbal consent can otherwise create uncertainty when the people responsible change.

Finally, check that the draft agreement, pre-contract information and verbal presentations all convey the same message. If the clause changes during negotiations, the information must also be updated, and the prospective franchisee should have a genuine opportunity to understand the change before signing.

Practical takeaway: first write down the risk you want to prevent. Then define the conduct, scope and duration of the restriction, consider less restrictive alternatives and obtain a legal review before using the clause.