Legitimate Business Interests in a Non-Competition Agreement

Non-competition provisions are written to protect the brand and the entire franchise community by restricting a franchisee’s ability to disclose the trade secrets of the franchisor. In its simplest terms, a franchisee is agreeing not to compete against the franchisor in exchange for receiving the trade secrets of the franchisor.

To enforce a non-competition provision, the franchisor must show that the restriction is designed to safeguard a legitimate business interest of the franchisor. A legitimate business interest encompasses many things, including such things as methods of operation, training, goodwill, customer lists, referral sources and the like.

1. Goodwill. Goodwill typically refers to a relationship between a company and its customers that results in continuing business. The goodwill of a franchise chain generally belongs to the franchisor. First, this is typically written into a franchise agreement. Second, it is believed that the goodwill results from the methods of operation and trademarks of a franchisor.

2. Prospective Customer Lists, Customer Lists and Referral Lists. Prospective clients or customers may also be protectable interest. Whether they are a legitimate business interest is determined by several factors. How much time, cost and efforts went into cultivating the list? Is the list available to the general public? How dependent is a particular industry on the use of customer lists and the like? The more efforts a franchisor has taken to cultivate a customer list; including teaching a franchisee to cultivate such a list, the more likely it will be deemed a protectable business interest. However, if the customer list is a phone book or online source available to the public, then that is not a protectible business interest for the franchisor.

3. Extraordinary or specialized training. Training is one item a franchisor gives to the franchisee. However, the training must be extraordinary or specialized. Most methods of operations that are unique to a franchise system are considered “extraordinary or specialized training.” However, what about a trade? If an electrician purchased a franchise specializing in electrical services, can the franchisor use a non-competition agreement to stop that electrician from continuing his or her trade after the franchise agreement is terminated? In most instances, the answer is no. What a franchisor can protect is the “unique” methods of operation in the system. This is generally management and operational trade secrets; but not the actual electrical services provided to the customer.

4. Confidential Information. Confidential information constitutes a legitimate business interest to enforce a non-compete provision. For the information to be considered “confidential information”, it cannot be known to the general public. Therefore, front of the house activity is generally not confidential information because it can be seen by the public. Pricing, profit margins, back of the house operations are generally confidential information.

This is not an exhaustive list of legitimate business interest. Underlying all protectible business interest is a level of availability to the general public and the efforts taken to ensure the interest remains secret. If everyone knows your “secret sauce”, then it is not a protectible business interest. Without a protectible business interest, there is no enforceability of a non-competition agreement.