Non-compete clause in franchise

The non-compete clause in the franchise

A non-compete clause restricts the franchisee's ability to engage in competing activities, both during and after the term of the franchise agreement. For the franchisor, such a clause is an instrument to protect the know-how and the business model. For the franchisee, however, the clause can have far-reaching consequences: it may prevent him from continuing to do business in the same industry or area after the end of the franchise. The Franchise Act has therefore set strict limits on post-contractual non-compete clauses to prevent the franchisee from being disproportionately restricted in his entrepreneurship.

Who do we work for?

We assist franchisors who wish to draft a valid and enforceable non-compete clause that protects the franchise system without exceeding legal limits, and franchisees who want to know whether the clause to which they are bound is legally valid and whether they may continue doing business after the termination of the franchise. Additionally, we advise on disputes regarding the interpretation, validity, and enforcement of a non-compete clause.

The statutory limits of Article 7:920 paragraph 2 of the Dutch Civil Code

Article 7:920 paragraph 2 of the Dutch Civil Code sets strict cumulative conditions for a non-compete clause that restricts the franchisee after the termination of the agreement. The clause must be agreed upon in writing. It may relate exclusively to goods or services that compete with those to which the franchise agreement relates. It must be indispensable to protect the know-how transferred by the franchisor to the franchisee. It may not extend geographically beyond the area within which the franchisee has operated the formula pursuant to the agreement. And it may apply for at most one year after the termination of the franchise agreement. A clause that does not satisfy all these conditions is void.

The clause during the term

During the term of the agreement, a non-compete clause is common and, in principle, permitted: it is logical that a franchisee dedicates themselves fully to the formula during the collaboration and does not engage in competing activities. However, here too, the clause must not be unreasonably broad and must not conflict with competition law, in particular the Group Exemption for Vertical Agreements. The limits during the term are broader than after the end, but not unlimited.

Nullity and the consequences thereof

The consequences of exceeding statutory limits are far-reaching. A post-contractual non-compete clause that does not meet all the conditions of Article 7:920 paragraph 2 of the Dutch Civil Code is void. This means that the franchisor cannot rely on it and that the franchisee is free to engage in competing activities. Whether partial nullity is possible, for example by reducing an excessively long term to the statutory maximum, is a question of conversion and interpretation that must be assessed on a case-by-case basis. It is therefore essential for the franchisor to formulate the clause within the limits from the outset.

Enforcement and disputes

If a departing franchisee fails to comply with a valid non-competition clause, the franchisor may enforce it by means of a formal demand and, if necessary, summary proceedings with a claim for an injunction and a penalty payment. If the franchisee believes that the clause is void or disproportionately restricts him, he may challenge its validity or seek a declaratory judgment. The outcome depends heavily on the precise wording of the clause and the factual situation. Speed ​​is often decisive in enforcement.

Our working method

For franchisors, we draft a non-compete clause that protects the franchise formula and remains within legal limits, or we assess the validity of an existing clause. For franchisees, we assess whether the clause to which they appear to be bound is legally valid and what scope they have to continue their business operations. In the event of a dispute, we determine the most effective course of action, taking into account the need for speed in enforcement or defense.

The central role of know-how

Know-how is the pivotal element around which non-compete clauses in franchising revolve. After all, Article 7:920 paragraph 2 of the Dutch Civil Code requires that the clause be indispensable to protect the know-how transferred by the franchisor. Case law imposes high standards in this regard: it must concern information that is essential to the franchise formula, is concretely identifiable, and is not generally accessible. Standard manuals, customary industry knowledge, or general guidance do not suffice. Recent rulings by the District Court of Amsterdam and the District Court of Central Netherlands, among others, show that a franchisor who cannot concretely demonstrate which protectable know-how he has transferred cannot enforce his non-compete clause. For the franchisor, this means that he must clearly define in advance which know-how distinguishes the formula; for the franchisee, the lack of demonstrable know-how is often the strongest defense against an overly broad clause.

Conversion of a void clause

A frequently asked question is whether an overly broad non-compete clause can be reduced by conversion (Article 3:42 of the Dutch Civil Code) to what the law permits, for example, a term of five years reduced to one year. This is largely rejected in legal literature and case law. After all, a generous conversion would encourage franchisors to deliberately draft overly broad clauses, knowing that the court would bring the clause back within statutory limits anyway. This would undermine the deterrent and protective purpose of the Franchise Act. The prevailing view is therefore that void is truly void: pursuant to Article 7:922 of the Dutch Civil Code, the clause is deemed never to have existed. For the franchisor, this underscores the importance of formulating the clause correctly from the outset; for the franchisee, it offers opportunities when the clause exceeds the limits.

Non-compete clause versus non-solicitation clause

The non-compete clause is often confused with the solicitation clause. A non-compete clause prohibits the franchisee from engaging in competing activities in a general sense, whereas a non-solicitation clause prohibits him from approaching specific business relations, such as customers or suppliers of the franchise system. In practice, the boundary between the two is not always clear, and there is debate in case law regarding the extent to which a non-solicitation clause that effectively acts as a restriction on competition also falls under the strict conditions of Article 7:920 paragraph 2 of the Dutch Civil Code. It is therefore important for both franchisor and franchisee to clearly state which type of clause has been agreed upon and which statutory regime applies to it.

Competition law and the non-compete clause

In addition to the Franchise Act, competition law also plays a role. A non-compete clause is a vertical agreement that is assessed against the Group Exemption for Vertical Contracts and, by extension, against Article 101 TFEU and Article 6 of the Competition Act. A non-compete obligation that applies for longer than five years during the term of the agreement or that is too broad after the termination of the agreement may be inadmissible under competition law. The statutory limitation in Article 7:920 paragraph 2 of the Dutch Civil Code and the competition law limits reinforce each other: a clause that fails one test usually fails the other as well. We therefore always assess the clause in conjunction with competition law within the franchise.

Part of your franchise legal advice

The non-compete clause does not stand alone. It is linked to the protection of the formula, the intellectual property of the franchise formula , and the non-solicitation clause. Our mixed teams of lawyers and in-house counsel advise franchisors and franchisees on all these topics, from the international group rolling out a formula to the individual entrepreneur bound by a clause. Also, view our broader expertise in Franchise Legal Advice for the complete picture.