Narellan Franchise Pty Ltd v RBME Pty Ltd

Supreme Court of NSW|2022-06-24|Before: Richmond J

Judgment

The plaintiffs seek interlocutory relief to enforce post-contract restraints contained in two franchise agreements against the franchisee RBME Pty Ltd (the first defendant) (RBME) and two individuals who have at all material times been the sole shareholders of the franchisee, Tim Ranieri (second defendant) and Matthew Ranieri (third defendant). The plaintiffs also seek interlocutory relief to restrain the use by T & M Pools Pty Ltd (the fourth defendant) (T & M Pools), the sole shareholders and directors of which are the second and third defendants, of confidential information of the plaintiffs. I will refer to the second and third defendants as "Tim" and "Matthew" respectively, as the parties did at the hearing, with no disrespect intended.
After the proceedings were commenced the defendants agreed to give undertakings not to use the plaintiffs' confidential information and the first defendant agreed to give (and did provide to the court) an undertaking not to compete with the plaintiffs in substantially the same terms as the post-contract restraint under each franchise agreement. What remains in issue is whether an interlocutory injunction should be granted against the second and third defendants (Tim and Matthew) to enforce the post-contract restraint they agreed to under the franchise agreements.

Background

The group of companies of which the plaintiffs are members (Narellan Group) has operated a swimming pool manufacture, sales and installation business since 1972. In about 2002, the Narellan Group developed a franchise system for the distribution, marketing, sale and installation of swimming pools and associated products manufactured by the Narellan Group. It is now the largest franchised pool brand in Australia.
The Narellan Group presently has 35 franchisees across New South Wales, the Australian Capital Territory, Victoria, South Australia and Queensland. In the 12 months ended 31 May 2022, the Narellan Group supplied about 2,939 pools to its franchisees for installation. On average, each franchisee other than RBME installed 72 pools in that period. RBME installed 210 pools in that period.
The first plaintiff (Narellan Franchise Pty Ltd) (Franchisor) enters into a franchise agreement with each franchisee conferring rights to use the Franchisor's intellectual property and franchise system, and the second plaintiff (Narellan Pools Pty Ltd) (Supplier) enters into a separate agreement with each franchisee for the supply of in ground swimming pools and associated products.

The Defendants

Between 2008 and 2016, T & M Pools was a franchisee for two franchise areas in the Sydney region. Tim and Matthew each own 50% of the issued shares of T & M Pools. Both Tim and Matthew are directors, and Matthew is the secretary.
In around 2014 Tim and Matthew decided to change the structure of their business and established two new companies, RBME and CTJN Pty Ltd, with the intention that they would each take over one of the two franchises held by T & M Pools. Ultimately, only RBME was able to obtain a building licence and so on or about 5 May 2016, the Franchisor entered into two franchise agreements with RBME (Franchise Agreements). The first was entitled "Narellan Pools Franchise - Sydney North" (Sydney North Franchise Agreement) and was between the Franchisor, RBME as franchisee and Tim and Matthew as guarantors. Although the company named as the "Franchisee" in Item 1 of the Schedule is RBME, the execution clause states that the company executing as Franchisee is T & M Pools. The parties have proceeded for the purposes of this interlocutory hearing on the basis that the franchisee under this agreement was RBME.
The second was a franchise agreement entitled "Narellan Pools Franchise - Sydney City", between the Franchisor, RBME as franchisee and Tim and Matthew as guarantors (Sydney City Franchise Agreement).
By each of the Franchise Agreements, Tim and Matthew, as guarantors, jointly and severally, unconditionally guaranteed to the Franchisor the due performance and due observance by RBME of its obligations under the agreement.
For each Franchise Agreement, two additional agreements were executed at around the same time: first, a deed poll under which RBME gave confidentiality undertakings, a covenant not to compete in similar terms to cl 12.5 of the Franchise Agreement and a covenant not to disparage the Franchisor and/or the Business; and second, a supply agreement between the Supplier, RBME as franchisee and Tim and Matthew as guarantors providing for the supply of inground pools and spas and associated equipment during the currency of the Franchise Agreement.
The franchised area covered by each Franchise Agreement (referred to as the "Territory") is as follows: 1. for the Sydney City Franchise Agreement, the area within 76 identified postcodes covering the area bounded by Sydney Harbour/the Parramatta River to the north, the coast to the east, Botany Bay to the south and Homebush/Regents Park/Bankstown to the west; and 2. for the Sydney North Franchise Agreement, the area within 57 identified postcodes covering the area bounded by Ku-ring-gai Chase National Park to the north, the coast to the east, Sydney Harbour/the Parramatta River to the south and Hornsby/Ryde to the west.
The Sydney City Franchise Agreement had a five year term expiring on 30 April 2021 and the Sydney North Franchise Agreement had a six year term expiring on 30 April 2022.
The grant of the franchise is contained in cl 2.1 of each Franchise Agreement which provides: "The Franchisor grants to the Franchisee for the Term, and the Franchisee accepts, the right to operate and promote the Business in the Territory using the Intellectual Property in accordance with the terms of this Agreement."
This provision is complemented by cl 4.1 which makes the franchise right exclusive within the Territory and cl 5.1 which provides that the Franchisor "grants to [RBME] the right to use and access (as appropriate) the Intellectual Property during the Term in accordance with the terms and conditions of this Agreement".
The definitions of key terms used in these provisions are as follows: "Business means the business of selling and installing the Pools and Products (including the Core Range) in conjunction with the Name, Trade Mark and Logo in accordance with the System and the terms and conditions of this Agreement. "Database means the database compiled, and updated from time to time, by the Franchisor of franchisees, clients, the types of Pools and Products supplied and installed, the date the Pools and Products were supplied and installed, and any warranties or work performed, or claims made under any warranties. Intellectual Property means all present and future rights, title and interest in, relating to, contained in, or connected with: (a) The Operations Manual; (b) The System; (c) the Pools and Narellan Products; (d) the Trade Mark; (e) the Name/Logo; (f) the Merchandise; (g) the Numbers; (h) the Database; (i) the Web Site; (j) the NP Software; (k) the Intranet; and (l) copyright in the franchise documentation including the franchise agreement, terms and conditions, disclosure document, manuals, and promotional material. Operations Manual means the manual describing the System which is supplied to the Franchisee in written and/or electronic form by the Franchisor with this Agreement and as updated or amended, reviewed, added to or deleted from (sic) by the Franchisor time to time. Pools means the range of in ground pools and spas that the Group Supplier manufacturers or supplies for the Narellan Pools Franchise Network under the Name, Trade Mark and Logo from time to time. Products means the pool installation accessories being the range of pool associated products that are required for the installation of a Pool as determined from time to time by the Franchisor and which form part of Pools sold and installed. System means the method and system of marketing, supplying and installing the Pools and Products in accordance with the Operations Manual and the directions of the Franchisor."
The "Name" is "Narellan Pools" and the "Trade Mark" comprises various registered trade marks. It may be noted that the definition of "Intellectual Property" includes some items which are separate items of property, such as registered trade marks and copyright, and others which are simply aspects of the Franchisor's goodwill.
Each Franchise Agreement includes, relevantly, the following terms: 1. RBME was not to actively market or promote the Business outside the Territory and was not to supply and install Pools or Products, as defined in the agreement, to clients who resided outside the territory without prior written consent: cl 4.2. 2. RBME was to comply with the Operations Manual: cl 6.2. 3. RBME was required to pay an upfront fee for the grant of the franchise (referred to as a "territory acquisition fee"), a "brand and territory fee" payable monthly as well as a contribution to the "national advertising fund": cl 7.2, 7.4 and 7.5. 4. RBME was to supply and install the Pools and Products, and no other competing pools or pool accessories and products, unless it obtained written consent from the Franchisor: cl 8C.1. 5. RBME and its Nominated Managers (see below) were to exercise their best efforts and devote full time and attention to promoting and maximising sales of the Pools and Products: cl 8D.6. 6. RBME was only to operate the Business, and was not to operate any other business without the prior written approval of the Franchisor: cl 8D.2. 7. RBME was to nominate a senior officer as the Nominated Manager. The Nominated Manager was responsible for supervision of the affairs of the Business and ensuring compliance with the agreement. They were to perform RBME's obligations under the agreement faithfully, honestly and diligently at all times; cl 8D.4(a). Tim and Matthew were the Nominated Managers for RBME: Schedule, item 11. 8. RBME, Tim and Matthew were to exercise their best efforts and devote their full time and attention to marketing, selling, supplying and installing Pools and Products, and obtaining and maintain the goodwill of clients: cl 8D.6. 9. The Franchisor was to provide to RBME all training which the Franchisor determined was reasonably required and necessary for the efficient and proper operation of the Business: cl 9B. 10. RBME, Tim and Matthew were not to use or disclose any Confidential Information, as defined in the agreement, during the term of the agreement or at any time thereafter, without the prior written consent of the Franchisor: cl 8F.1. 11. RBME, Tim and Matthew were to give prompt, courteous and efficient service to clients and the public and be governed by the highest ethical standards of honesty and business conduct in order to enhance the identity, reputation and goodwill of the Franchisor": cl 8K.1(d). 12. The agreement was to be governed by and construed in accordance with the laws of New South Wales: cl 22.
During the term of each Franchise Agreement, the Franchisor gave written consent to RBME for it to (a) on-sell pools purchased from the Supplier to a wholly-owned subsidiary of RBME; (b) operate a landscaping business in order to provide landscaping around pools; and (c) operate an excavation business. I understand it is not in dispute that these were the only approvals which the Franchisor granted to the defendants to operate outside the terms of the Franchise Agreements. The approval referred to in (a) was subject to a number of conditions some of which, including that the contract with end customers must be entered into by RBME, do not appear to have been satisfied.
Following the expiry of the term of the Sydney City Franchise Agreement on 30 April 2021, RBME continued to operate the Sydney City franchise on a month-to-month basis under cl 3.4 of that agreement which provides as follows: "3.4 Month to month franchise Should this Agreement terminate or expire for any reason and the Franchisor allows the Business to continue to be conducted by the Franchisee after the date of termination or expiration (as the case may be), then without prejudice to any rights or remedies the Franchisor may have: 1. the Franchisee may continue to operate the Business under licence on a monthly basis; 2. that licence may be terminated by either party on one month's written notice to the other party; and 3. the terms of that licence of the Business are: 1. those set out in this Agreement, as appropriate; or 2. those contained in the then current form of franchise agreement, as notified to the Franchisee and as appropriate."

Contracts with the franchisee's customers

The evidence as to the process whereby contracts with end customers came about and were performed can be summarised as follows: 1. Contracts with end customers result from "leads" generated by the marketing efforts of both the Franchisor and the franchisee. A "lead" is an enquiry by a potential customer for a proposal for a new pool to be installed, and would generally involve either a phone call to the Franchisor's 1300 telephone number or an enquiry made on the Franchisor's web site irrespective of whether the marketing was organised by the Franchisor or T & M Pools, or in some cases an enquiry direct to T & M Pools. An enquiry to the Franchisor would result in the Franchisor through its "customer relationship manager system" causing an email to be sent to the franchisee in the territory where the customer was located. 2. The evidence did not establish the exact proportion of the contracts which T & M Pools entered into with end customers which resulted from leads generated by the Franchisor, but it does indicate that it was a significant proportion. Further, the evidence was that the steady generation of leads is a crucial component of the long-term success of a pool installation business. 3. A representative of T & M Pools would then conduct a site visit with the prospective customer and present a proposal. If the proposal was accepted by the prospective customer, T & M Pools would enter into a contract with the customer in the Franchisor's standard form (see below). 4. Once the contract was entered into, T & M Pools then placed an order with the Supplier for the pool shell, liaised with the customer through one of its site managers regarding the obtaining of the necessary council approvals (a process which could take anywhere from between 2 weeks to 6 months), co-ordinates with sub-contractors for pre-installation works, co-ordinates with sub-contractors for the installation of the pool (a process which can take anywhere from a few days to three weeks depending on the site). The average time frame from a client submitting an order to final installation is 2-3 months, although on occasion it can take as long as 6 months. The whole process was described by Matthew in his evidence as "a highly orchestrated and dynamic process".
During the term of each Franchise Agreement the person named in contracts with end customers as the entity agreeing to supply and install the Narellan pool and associated equipment was T & M Pools (described as "T & M Pools Pty Ltd trading as Narellan Pools") rather than RBME. It is likely that there will be an issue at the final hearing whether this was a breach of the Franchise Agreement, but that issue does not need to be addressed now. These contracts were generally in the same form as the standard form contract contained in the Operations Manual, subject to one exception. The exception is that from around 31 January 2022, T & M Pools' contracts with customers ceased to include "Narellan Pools" on its front page (or, it seems, elsewhere) and included the following clause (Substitution Clause): "… [T & M Pools] may substitute any or all Equipment for equipment of similar function, quality, and cost at [T & M Pools'] absolute discretion."
The term "Equipment" is defined in cl 8 as follows: "'Equipment' means the pool shell, filtration equipment and accessories, manual pool cleaning equipment, heater and Spa provided by [T & M Pools] under this Contract."
At the time of the hearing: 1. T & M Pools had 197 contracts on foot with customers, a significant proportion of which came from leads generated by the Franchisor (in the order of at least 35%, with the precise figure being in dispute); 2. 73 of those contracts included the Substitution Clause; and 3. T & M Pools had (after 1 June 2022) contacted 179 of the customers to offer them pool shells manufactured by Aquatic Leisure Technologies Pty Ltd (ALT), which is now T & M Pools' supplier of pool shells. ALT owns and operates a factory in Western Australia
Following those approaches to customers, T & M Pools received 67 signed "variation to contract" forms by customers who wished to vary their existing contracts such that they will receive an ALT pool installed by T & M Pools.
Of the customers with contracts which did not include the Substitution Clause, some 42 of those customers had, at the time of the hearing, agreed to vary their contracts with T & M Pools to receive an ALT pool. Most of the remainder had indicated to T & M Pools that they will approve that variation upon receiving confirmation that the substituted pool will be approved by Council. The evidence was that only 4 customers have expressly indicated they do not wish to vary their contracts.
Matthew gave evidence that based on the current rate at which T & M Pools customers were varying their contracts, he expected that T & M Pools will secure executed variation approvals for between 60% and 80% of T & M Pools' pre-June 2022 customer base by the end of July 2022, and expects T & M Pools to secure variation approvals from most of the remaining customers in August and September 2022.
T & M Pools has submitted 29 orders to ALT for pool shells with a range of delivery times between 1 June 2022 and 31 July 2022. T & M Pools is in the process of finalising a further 25 pool shell orders for August 2022.

The contractual restraint

Clause 12.5(b) of each Franchise Agreement contains a restraint on competition following termination or expiration of the agreement, in the following terms: "(b) After termination or expiration For a period of 12 months, or if such period is unenforceable then 6 months, from the date of termination or expiration of this agreement, [RBME] and the Guarantor(s), and [RBME's] directors and shareholders, and the Nominated Manager(s) (where appointed) jointly and severally covenant and agree with the Franchisor (in consideration of the Franchisor entering into this Agreement and as part of the terms and conditions of the grant of the Franchise) that any of [RBME] or the Guarantor(s) or the Nominated Manager(s) (where appointed) shall not either directly or indirectly, either alone or in partnership, or as a director or shareholder of any company, or as an employee, consultant, lender, representative, agent, advisor or otherwise: 1. be engaged in, carry on any business or obtain a direct or indirect benefit from a business which is similar to the Business or offers Products or Pools (or products and/or pools similar to the Products and/or Pools) within the Restraint Area [defined as the Territory in cl 1.1]; 2. solicit any clients of the Business or other Franchisees including those listed on the Database; 3. otherwise market the Products or Pools or similar products or pools within the Restraint Area."
The "Restraint Area" is the same as the Territory under the Franchise Agreement. Tim and Matthew are "Guarantors" and "Nominated Managers" as those terms are used in cl 12.5(b) of the Franchise Agreements. As they executed each Franchise Agreement as Guarantor, they are bound by cl 12.5(b) if it is valid.
Clause 12.5(b) needs to be read with cl 5.8 of each Franchise Agreement which provides as follows: "The Franchisee recognises and acknowledges that all goodwill accruing to the Intellectual Property accrues to the exclusive benefit of the Franchisor, or its associated companies and that the Franchisee accrues no interest or right in such goodwill. The Franchisor acknowledges that the Franchisee is entitled to local goodwill relating to the local operation of its Business for so long as this agreement is in force, but is not entitled to goodwill, or to be compensated by the Franchisor for the loss of such goodwill, upon termination or expiration of this agreement, except in the case of transfer in accordance with cl 13."

Position on expiry of the term of the Franchise Agreement

It is necessary to refer briefly to the provisions of the Franchise Agreement which govern the position on expiry of the term of the agreement.
There is a procedure in cl 3.2 for the Franchisor to notify the franchisee 7 months before the expiry of the term if the Franchisor wishes to renew the agreement for a further 5 year term. If the Franchisor gives such notice, the franchisee must notify the Franchisor no later than 6 months before expiry of the initial term whether it wishes to accept that offer. In the present case, Tim and Matthew gave notice in October 2020 that they accepted the Franchisor's offer to renew both Agreements although ultimately this did not occur.
In the event that the agreement is not renewed there are two possibilities. The first is that the franchisee transfers its business, including its rights under the agreement, to a third party subject to compliance with the requirements set out in cl 13.2 to 13.6, including obtaining the prior consent of the Franchisor (cl 13.2). These provisions would permit the franchisee to transfer its business to a new franchisee on the expiry of the term, including the benefit of uncompleted executory contracts with customers.
The second alternative is that the agreement simply comes to an end. Clause 12.1 contains provisions dealing with the consequences of expiry of the agreement. It provides, inter alia, that the franchisee must cease to use the Franchisor's Intellectual Property and confidential information and return to the Franchisor all confidential information in its possession. It also provides that the Franchisor may (but is not required to) contact approved suppliers (including the Supplier) and cancel any outstanding orders for pools and products. Clause 12.2 also gives the Franchisor the option to purchase the Pools and Products held by the franchisee at fair market value.
The Franchise Agreement is silent as to whether the franchisee can perform executory contracts for the supply and installation of pools and products which are uncompleted at the date of expiry of the agreement, although cl 8.1 of the Supply Agreement states that the second defendant is entitled to complete any sale of any order made prior to expiry of the Franchise Agreement. Prima facie, the position is that the parties will need to enter into an arrangement for how executory contracts extant at the date of expiry of the Franchise Agreement are to be completed, the most obvious solution being for the franchisee to take advantage of the month-to-month licence contained in cl 3.4 to "run down" its outstanding contracts until they are all completed.
What is the position if, instead, the franchisee sought to perform the executory contracts by supplying a different pool and associated products to the customer following the expiry of the Franchise Agreement? In my view, that would involve the franchisee taking advantage of the "local goodwill" which the franchisee had agreed to give up under cl 5.8 of the Franchise Agreement on expiry and prima facie, the franchisee would be in breach of cl 12.5(b) if it sought to perform those contracts in that way.

Circumstances surrounding expiry of the Franchise Agreements

As noted above, in October 2020 Tim and Matthew gave notice to the Franchisor of their intention to accept the Franchisor's offer of a new franchise for a further 5 year term for each Territory. However, the relationship between the parties deteriorated during 2021. Rightly or wrongly, Tim and Matthew and a number of other franchisees became dissatisfied with delays in the supply and quality of pools supplied by the supplier and certain other matters including pricing, which are mostly disputed by the Franchisor although it acknowledges that there were challenges to supply resulting from a fire at the Supplier's factory in December 2020 and the impacts of the COVID-19 pandemic. I mention this only because it explains why on 30 March 2022 the solicitors for RBME wrote to the Franchisor informing it that RBME would not proceed with the renewal of the Franchise Agreements and said: "… the Franchisee no longer wishes to continue the Franchisee's relationship with the Franchisor. Accordingly, we are instructed that our Clients will: (i) cease trading as a Narellan Pools Franchisee for Sydney North at the end of the Term (as defined in the Sydney North FA), and (ii) terminate the monthly licence for the Sydney City FA. This letter should be treated as the requisite one month's notice required under the Sydney City FA. Given that the Sydney City FA is due to expire on 1 May 2022, our Clients are prepared to continue to operate the Sydney City FA until the expiry date of the Sydney North FA. Our clients are prepared to work with the Franchisor to discuss the next steps. In this regard, we suggest arranging an informal meeting with the franchisor in order to discuss and agree on a mutually acceptable arrangement to bring the commercial relationship between the parties to an end. Given the reputation of both the franchisor and our Clients, it is imperative that the parties work co-operatively to reach an amicable outcome minimising any risk to reputation or brand damage."
On 8 April 2022 the Franchisor's solicitors responded to this letter confirming that both Franchise Agreements would expire on 1 May 2022 and drawing the attention of RBME to a number of provisions of the Franchise Agreements including the non-competition obligations contained in cl 12.5(b). The letter also noted that the Franchisor "will be refranchising the territories, so protection of our Intellectual Property and the agreed restraints are important given the value of the territories".
During April 2022 the Franchisor had discussions with Tim and Matthew as to making transitional arrangements for the termination of the Franchise Agreements including the possibility of entering into a distribution agreement to provide for RBME to install pools which were the subject of uncompleted executory contracts entered into during the term of the Franchise Agreements.
On 22 April 2022, Tim sent an email to the Franchisor stating that: "We would like to extend both franchise agreements completion dates by one month which will see them both conclude at the 31st of May 2022. I will aim to have you something early next week on the order bank, Mark is working on this now. We are still in the process of getting advice following our last meeting and we are hoping to get back to you regarding the distributor agreement next week."
Ultimately nothing came of the proposal for a distributor agreement but the parties did proceed on the basis that both Franchise Agreements would continue to operate until 31 May 2022.

Relevant principles

As this is an interlocutory hearing and not a final hearing it is not the function of the court to undertake a preliminary trial and to give or withhold relief upon some forecast as to the ultimate result of the factual disputes between the parties: Beecham Group Ltd v Bristol Laboratories Pty Ltd (1968) 118 CLR 618 (Beecham) at 622; [1968] HCA 1.
The questions which arise, on which the plaintiffs bear the onus are: (a) first, whether there is a serious question to be tried that the post-contract restraint contained in cl 12.5(b) of the Franchise Agreements is valid (i.e. a prima facie case in the sense referred to in Beecham at 622); (b) second, whether either plaintiff is likely to suffer injury for which damages are an inadequate remedy; (c) third, whether the balance of convenience favours the granting of the injunction and (d) fourth, whether there are any discretionary factors which tend against the granting of relief: Australian Broadcasting Corporation v O'Neill (2006) 227 CLR 57; [2006] HCA 46 at 68 [19]; HiTech Group Australia Ltd v Riachi [2021] NSWSC 1212 (HiTech) at [31]; JD Heydon, The Restraint of Trade Doctrine (4th ed, 2018, LexisNexis Butterworths) at 337.
The parties were in agreement that only the first and third questions are at issue in this interlocutory application.
The period of the post-contract restraint in cl 12.5(b) of the Franchise Agreements (subject to the matter raised in [87] below concerning the Sydney City Franchise Agreement) is 12 months ending in April or May 2023. Hence, it cannot be said that the grant of interlocutory relief will in a practical sense determine the dispute between the parties. Consequently, it is not necessary for the court to evaluate the strength of the plaintiff's case for final relief: Kolback Securities Ltd v Epoch Mining NL (1987) 8 NSWLR 533 (Kolback) at 536. However, an assessment of the strength of the plaintiff's case will be relevant to the balance of convenience albeit on a preliminary basis reflecting that the arguments are to be weighed at a relatively high level at an interlocutory hearing: HiTech at [36]; SAI Global Property Division Pty Ltd v Jones [2018] NSWSC 438 (SAI Global) at [103] and [115].
The principles under the common law and the Restraints of Trade Act 1976 (NSW) relevant to the enforceability of restraints of trade in commercial agreements are well settled. They were summarised by Gleeson JA (with whom Bathurst CJ and Beazley P agreed) in Isaac v Dargan Financial Pty Ltd (2018) 98 NSWLR 343; [2018] NSWCA 163 at [59]-[74] and I set out below those parts of the summary relevant to the present matter: "[59] At common law a restraint of trade is contrary to public policy and void unless justified by the special circumstances of the particular case. A restraint may be enforced if the restraint is reasonably necessary for the protection of the parties concerned and reasonable in the interests of the public: Nordenfelt v The Maxim Nordenfelt Guns and Ammunition Company Ltd [1894] AC 535 at 565 (Lord Macnaghten); Lindner v Murdock's Garage (1950) 83 CLR 628 at 633 (Latham CJ); [1950] HCA 48; Buckley v Tutty (1971) 125 CLR 353 at 376, 379-380; [1971] HCA 71. [60] In New South Wales, it is necessary to have regard to the Restraints of Trade Act 1976 (NSW) which relevantly provides in s 4: "4 Extent to which restraint of trade valid (1) A restraint of trade is valid to the extent to which it is not against public policy, whether it is in severable terms or not. (2) Subsection (1) does not affect the invalidity of a restraint of trade by reason of any matter other than public policy. (3) Where, on application by a person subject to the restraint, it appears to the Supreme Court that a restraint of trade is, as regards its application to the applicant, against public policy to any extent by reason of, or partly by reason of, a manifest failure by a person who created or joined in creating the restraint to attempt to make the restraint a reasonable restraint, the Court, having regard to the circumstances in which the restraint was created, may, on such terms as the Court thinks fit, order that the restraint be, as regards its application to the applicant, altogether invalid or valid to such extent only (not exceeding the extent to which the restraint is not against public policy) as the Court thinks fit and any such order shall, notwithstanding sub-section (1), have effect on and from such date (not being a date earlier than the date on which the order was made) as is specified in the order.…" [61] The correct approach to the application of s 4(1) of the Restraints of Trade Act is well settled. In Orton v Melman [1981] 1 NSWLR 583 at 587 McLelland J (as his Honour then was) explained that first, the court determines whether the alleged breach (independently of public policy considerations) does or will infringe the terms of the restraint properly construed. Next, the court determines whether the restraint, so far as it applies to that breach, is contrary to public policy. If it is not, the restraint is valid, subject to any order which may be made under s 4(3). These principles have been approved in later cases including in this court: Wright v Gasweld Pty Ltd (1991) 22 NSWLR 317 at 328; Woolworths Ltd v Olson [2004] NSWCA 372 at [42]-[44]; Jardin v Metcash Ltd (2011) 214 IR 448; [2011] NSWCA 409 at [87]. [62] The effect of s 4(1) of the Restraints of Trade Act is to require, for the purpose of determining the validity of a restraint, that attention be focused on the actual or apprehended breach, rather than on imaginary or potential breaches: Cactus Imaging Pty Ltd v Peters (2006) 71 NSWLR 9; [2006] NSWSC 717 at [10] (Brereton J). [63] The validity of a covenant in restraint of trade is to be judged at the date of its creation: Lindner v Murdock's Garage at 653 (Kitto J); Amoco Australia Pty Ltd v Rocca Bros Motor Engineering Co Pty Ltd (1973) 133 CLR 288 at 318 (Gibbs J); [1973] HCA 40; Geraghty v Minter (1979) 142 CLR 177 at 181 (Barwick CJ); [1979] HCA 42. Nonetheless, the court may take into account future events that could have been foreseen: Lindner v Murdock's Garage at 653. Hence, when exercising its discretion whether or not to grant relief, the court considers matters as at the date of the hearing: Sidameneo (No 456) Pty Ltd v Alexander [2011] NSWCA 418 at [70] (Young JA; Beazley and Basten JJA agreeing); Tullett Prebon (Australia) Pty Ltd v Purcell (2008) 175 IR 414 at 440; [2008] NSWSC 852 at [88] (Brereton J). [64] The nature of the interest meriting protection under a covenant in restraint of trade will differ according to the type of restraint under consideration. In Tullett Prebon (Australia) Pty Ltd v Purcell, a case involving restraints in an employment case, Brereton J said at [47]: "[47] … Whether a restraint is reasonable having regard to the interests of the parties depends on two, albeit related, considerations: first, whether the covenantee has a legitimate protectable interest, and secondly, whether the restraint is no more than reasonable for the legitimate protection of that interest. A covenantee is not entitled to be protected against mere competition; the legitimate interests which may be the subject of protection by covenant are in the nature of proprietary subject matter [Vandervell Products Ltd v McLeod [1957] RPC 185; Tank Lining Corp v Dunlop Industries Ltd (1982) 40 OR (2d) 219; 140 DLR (3d) 659 at 664], including trade secrets and confidential information, and goodwill including customer connection." [65] However as Young JA explained in Sidameneo (No 456) Pty Ltd v Alexander at [31]-[32], the word "proprietary" is used in a special sense and will include legitimate commercial interests. The legitimate business interests which are capable of protection by a restraint include the employer's goodwill (including customer connection) and confidential information, and the maintenance of a stable and trained workforce: SAI Global at [111]. However, an employer has no legitimate interest in merely preventing a former employee from taking employment with a competitor: Tullett Prebon (Australia) Pty Ltd v Purcell [2008] NSWSC 852; 175 IR 414 (Tullett Prebon) at [47]."
In the context of a franchise agreement, the legitimate interests which are capable of protection by a post-contract restraint of the kind found in cl 12.5(b) include the franchisor's confidential information and knowhow, and goodwill. In the present case, the first plaintiff did not seek to support cl 12.5(b) in relation to the protection of confidential information and knowhow, but rather relied on the protection of its goodwill.
In Federal Commissioner of Taxation v Murry (1998) 193 CLR 605; [1998] HCA 42, Gaudron, McHugh, Gummow and Hayne JJ said that the attraction of custom is central to the legal concept of goodwill ([20] and [68]) and gave the following definition of goodwill for legal purposes: "[23] From the viewpoint of the proprietors of a business and subsequent purchasers, goodwill is an asset of the business because it is the valuable right or privilege to use the other assets of the business as a business to produce income. It is the right or privilege to make use of all that constitutes 'the attractive force which brings in custom'. Goodwill is correctly identified as property, therefore, it is the legal right or privilege to conduct a business in substantially the same manner and by substantially the same means that have attracted custom to it. It is a right or privilege that is inseparable from the conduct of the business." (Underlining added)
The following propositions relevant to this matter can be drawn from the joint judgment. [1] Goodwill is inseverable from the business to which it relates and cannot be transferred without transferring that business: [30]. The goodwill of a business is the product of combining and using the tangible, intangible and human assets of a business so as to attract custom to it: [24]. While it is common to describe goodwill as composed of elements, it is more accurate to describe goodwill as having sources than as composed of elements: [24]. Goodwill may have various sources, some of which may constitute property and some of which may not. For example, the goodwill of a business may be referable "in part of its locality, in part to the way in which it is conducted and the personality of those who conduct it, and in part to the likelihood of competition …": [24], [68]. However, it is necessary to distinguish those sources from the goodwill itself because goodwill is an item of property and an asset in its own right separate from the sources that give rise to it: [30], [44].
It can be inferred from the evidence that the Franchisor's goodwill has a number of sources and that while some comprise separate items of property (such as registered trade marks and copyright), many do not.
Given the inseparable connection between goodwill and the business to which it relates, it is necessary in the franchise context to identify the nature of the businesses conducted by the franchisor and the franchisee. Generally, it can be said that the business in which the franchisor is engaged is, in substance, the granting to others of the right to use the franchisor's trading or brand name and system for the supply of goods or services to the public. A licence to use the trading or brand name of the franchisor (as distinct from its registered trade mark or marks) and franchise system is valid as essentially a licence of the franchisor's goodwill. [2] Each franchisee is engaged in a business of supplying those goods or services to the public with the benefit of the licence from the franchisor. Those two businesses are separate albeit symbiotic [3] , and each is capable of having a separate goodwill. However, absent agreement to the contrary, the franchisor will own the goodwill associated with the franchisor's brand quoad the public arising from the conduct of the franchisee's business of selling goods or services to the public under that brand. [4] The successful conduct of the franchisee's business will potentially enhance the franchisor's goodwill thereby increasing its fee income from existing franchisees and its ability to attract new franchisees at a suitable level of fees, as well as increasing the franchisor's profit from the sale of the franchised goods or services.
The franchisee may, in an appropriate case, generate goodwill separate from the goodwill attaching to the franchisor's brand which, absent agreement to the contrary, the franchisee may own. The franchise agreement will normally make clear that all goodwill accruing to the brand during the term of the franchise agreement will be owned by the franchisor in order to preserve the franchisor's ability to protect its goodwill associated with the brand by an action for passing off or for misleading and deceptive conduct.
The Franchise Agreements in the present case follow this norm. Clause 5.8 (set out above) provides that all goodwill accruing to the "Intellectual Property" (as defined) accrues to the exclusive benefit of the Franchisor. While the definition of "Intellectual Property" does not refer to goodwill it refers to aspects or sources of the Franchisor's goodwill, including the trade name "Narellan Pools" and the "System". While cl 5.8 acknowledges that the franchisee is entitled to "local goodwill relating to the local operation of its Business" during the term of the agreement that ceases upon expiry or termination of the agreement except as provided in cl 13 (which is the provision permitting the franchisee to sell its business, including its rights under the agreement, to a third party with the consent of the Franchisor). Consequently its right to use that "local goodwill" comes to an end at that time.
A legitimate business interest of the franchisor which a post-contract restraint may, if reasonable, protect is to prevent the outgoing franchisee for a period of time from continuing to operate in its former territory and competing in the same line of business, so as to enable the franchisor to exploit the goodwill that the franchisee has built up during the term, by recruiting another franchisee for the same territory. [5]
In Dyno-Rod Plc v Reeve [1999] FSR 148 (Dyno-Rod) an interlocutory injunction was granted to enforce a 12 month post-contract restraint on the outgoing franchisee engaging in a business in the franchise territory in competition with the franchisor. The franchise business was a drainage services business and the franchise agreement stated that the use by the franchisee of the franchisor's trade name would inure to the benefit of the franchisor along with any goodwill arising therefrom. Neuberger J granted an interlocutory injunction and said at 155: "The plaintiff is anxious to protect its business within the area. In that connection, now that the agreement with Mr Reeve is determined, the plaintiff wishes to enter into a new arrangement with a fresh franchisee. The plaintiff's primary concern in seeking the present injunction is to protect its goodwill in the area and to protect its ability to enter into a fresh arrangement for such incoming franchisee, and indeed to find such an incoming franchisee. As Mr Tritton says, it is not from other drain-cleaning businesses that an incoming franchisee needs protection or, I add, could conceivably be entitled to protection, it is from the plaintiff's own ex-franchisees an incoming franchisee is entitled to protection, provided that that protection is reasonable. In this case the protection sought and contractually agreed to is for one year, and is only within the area. It is obvious that the plaintiff will be likely, and one will have to judge this at the date of the agreement, to have far greater difficulty in attracting a new franchisee if the ex-franchisee is known as a Dyno-Rod franchisee, with all the Dyno-Rod experience and contacts and is operating in the territory. An ex-franchisee has the benefit of considerable investment by the plaintiff, which puts the ex-franchisee in a better position than others. Providing that it is reasonable in terms of the public interest and not unfair to the ex-franchisee in terms of time or area, the plaintiff is entitled, in my judgment, to ensure that his investments are protected by ensuring that unfair advantage is not taken by an ex-franchisee by, for instance, prematurely determining the franchise agreement and setting out on his own. That argument appears to me to receive support from the observations of Whitford J in Prontaprint, to which I have made reference. The ex-franchisee has the advantage of knowledge of local customer base, a point touched on by Lord Denning in Office Overload, Pricing Policies, Structure, Marketing Techniques and so on."
Later at 157, Neuberger J said: "The point is that mere solicitation of present or previous customers is not the plaintiff's primary concern. The defendants are trained Dyno-Rod cleaners and they can do whatever a new franchisee could do. They would be able to undercut any franchisee, apart from stealing a march on him in terms of knowing the area, the customers and knowing how the area, as it were, works. They would be able to undercut an incoming franchisee … The unfairness, it seems to me, of the defendants using their knowledge and experience gained by teaching manuals and experience, thanks to the plaintiffs, and use of the plaintiff's name, has to be balanced against the desirability or the undesirability of covenants of this sort. I have little hesitation in concluding that that balance is struck in favour of upholding the covenant by the terms of the covenant in the present case."
In Peart Stevenson Associates Ltd v Holland [2008] EWHC 1868 (Peart Stevenson), Judge Richard Seymour QC said, after setting out the above passage from Dyno-Rod: "[44] It is, I think, clear from that passage that the interest of the franchisor in restraining a former franchisee from competing with the franchised business in the territory in which the former franchisee operated consists in the impact such competition would have on a potential incoming franchisee replacing the former franchisee. That accords with common sense. However, the underlying justification for the restraint is important in the circumstances of the present case. As the public interest has to be considered, it would seem that a restraint against competition by a former franchisee would not be justified unless there was a benefit to the franchisor from the restraint. Without such a benefit, a restraint against carrying on the activity formerly carried on as a franchisee is simply a burden to the former franchisee and a detriment to the public, which is thus deprived of the economic activity of the former franchisee in the role which he previously performed."
In Chipsaway International Ltd v Kerr [2009] EWCA Civ 320 (Chipsaway) a 12 month post-contract restraint in a franchise agreement for a franchise business involving the repair of damage to the bodywork of cars was upheld on the same basis. Dyson LJ said: "[22] But the fundamental objection to the judge's interpretation is that it does not achieve a sensible commercial purpose. As Mr Evans Tovey points out, during the term of a franchise, goodwill is built up in the franchise territory with the use of a franchisor's name and branding. Such goodwill is a potentially valuable asset in the hands of the franchisee so long as he continues to trade in the franchise territory, and in the hands of a franchisor at the termination of the franchise agreement. A franchisor's interest in that goodwill is vulnerable to competition from a former franchisee who has knowledge of the area and experience of dealing with particular groups of customers. The commercial purpose of a post-termination covenant against competition is to prevent the franchisee for a period of time from continuing and competing in his former territory in the same line of business so as to enable the franchisor to exploit the goodwill that he has built up during the term, most obviously by recruiting another franchisee for the same area. See, for example, Prontaprint plc v Landon Litho Ltd [1987] FSR 315, 324, where Whitford J said: "It is of course apparent that the circumstances of this case differ from those of the sale of a piece of property but they are in my view rather closer to that situation than to the situation as between an employer and an employee. The Plaintiffs are in a franchising business. They want to grant franchises and have franchisees up and down the country, and for that purpose they want to ensure that they are in a position to prevent competition against franchisees whom they might appoint by persons who in fact built up their knowledge and interest as franchisees."
His Lordship then set out the passage from the judgment of Neuberger J in Dyno-Rod set out above, and continued: "[24] The purpose of cl 23.1(a), therefore, was to allow the Claimant a breathing space of twelve months in which to establish a replacement franchisee and to protect its goodwill, free from competition, from a franchisee who had previously operated within the franchise territory. The fact that, in the event, the Claimant did not seek to find a replacement franchisee in the months following the termination has no relevance. … But, as the authorities to which I have referred make clear, an important purpose served by restrictive covenants such as cl 23.1(a) is to protect the franchisor's goodwill and to protect its ability to find a replacement franchisee."
Similar considerations were relied upon by Austin J in KA & C Smith Pty Ltd v Ward (1998) 45 NSWLR 702 (Smith) in upholding a 2 year post-contract restraint in a franchise agreement. His Honour said at 722: "To assess the reasonableness of the restraint clause, it is necessary to identify the legitimate interests which the clause seeks to protect. This is not a case where the purchaser of a business seeks to protect the goodwill which it has acquired by restraining the vendor from competing; nor is it a case where an employer seeks to protect its confidential information by restraining a former employee from working for a competitor. A franchise agreement has some of the elements of both of these cases, although it is a commercial arrangement closer to the former than the latter: Prontaprint Plc v Landon Litho Ltd [1987] FSR 315 at 324; Stokely-Van Camp Inc v New Generation Beverages Pty Ltd (1998) 44 NSWLR 607 at 613. In my opinion, the franchisor has an interest at stake which is analogous to the purchaser's goodwill. It has an interest in protecting the patronage built up through the operation of the franchise, which may be lost if the franchisee is permitted to compete without restriction. The franchisor also has an interest in preserving the confidentiality of confidential information provided to the franchisee, which could be used by the franchisee to compete with the franchisor if there were no restraint. However, the franchisee has an interest in protecting the goodwill of its business. The customers are customers of the franchisee's business, though the franchisor also has an "interest" in the customers since they are attracted to the business as a franchise business. The question is whether the restraint clause in the second franchise agreement is too wide, given the nature of the franchisor's interest and the need to balance the interests of franchisor and franchisee."
Later at 723-724 his Honour said: "To preserve the franchisor's "goodwill" (referred to above as an interest in the patronage of the franchised business and the confidentiality of products and processes), the franchisor needs time to obtain a substitute franchisee to work the franchise area, and the new franchisee needs time to become established. Direct competition by the former franchisee would be likely to damage the transition process. Given the nature of the business and the expertise which needs to be acquired by tuition or self-teaching or both, a two year restraint is appropriate."
The plaintiffs relied on these decisions as establishing the legitimate interest protected by cl 12.5(b).
In BB Australia Pty Ltd v Karioi Pty Ltd [2010] NSWCA 347; 278 ALR 105 (BB Australia), Macfarlan JA (with whom Gyles JA and Sackville AJA agreed) distinguished Dyno-Rod, Chipsaway and Smith. It is necessary to consider carefully the facts in BB Australia in order to understand why that is so, particularly as this decision was strongly relied on by the defendants in support of the contention that cl 12.5(b) is not enforceable.
BB Australia concerned the enforceability of post-contract restraints in two franchise agreements under which the appellant (Blockbuster) granted to the respondent (Karioi) the right to operate Karioi's existing video stores at two locations in Queensland as "Blockbuster Video Stores". When the franchise agreements came to an end, Karioi continued to operate the stores without the Blockbuster name and distinguishing features. Blockbuster sought to enforce post-contract restraints in the franchise agreements in order to prevent Karioi from continuing to conduct the video stores.
Each franchise agreement included a provision (cl 32) which conferred on Blockbuster the right to acquire the franchisee's assets (including goodwill). Blockbuster did not exercise that option to purchase.
As the franchise agreements were governed by the law of Queensland, the enforceability of the post-contract restraints turned solely on the common law. Macfarlan JA posed the relevant question for validity at [67] as being whether at the date of the Agreements, reasonable people in the position of the parties would have expected that the performance of the agreements and the conduct of the franchised operations during the terms of those agreements would be likely to generate significant new goodwill in relation to those businesses which Blockbuster would own and which Blockbuster could reasonably protect by the restraint of trade provisions. That question needed to be determined in light of the three aspects which Blockbuster contended that its goodwill had, being: 1. the patronage of the stores as set out in the customer database; 2. an interest in the precise location of the stores; 3. the other intellectual property and confidential information preserved for Blockbuster's benefit, including information about its operating systems, marketing strategies and pricing structures.
In relation to the first aspect of Blockbuster's claimed goodwill, the evidence did not establish that the connection with existing customers of the video store was an independent aspect of any goodwill which Blockbuster owned. This was because, on the evidence, the goodwill of Blockbuster video stores, putting to one side who owned that goodwill, arose out of the location of the stores and their branding and not from an existing customer connection resulting from the personal service provided to those customers by the franchisee (at [72]). The location of the stores and their branding were matters covered by the other two claimed aspects of Blockbuster's goodwill.
In relation to the second aspect, being the location of the stores, Karioi had the right to occupy the premises used for each video store prior to commencement of the franchise, and Blockbuster did not exercise its option to purchase the franchisee's assets of the franchisee's business conducted at the video store premises (including goodwill). Hence, Blockbuster had no goodwill to protect based on the location of the two video stores (at [70]).
In relation to the third aspect, Blockbuster clearly had goodwill in relation to its brand and associated intellectual property. However, this was sufficiently protected by the restraints in other provisions of the franchise agreements on Karioi using the Blockbuster brand and associated intellectual property after termination (at [68]-[69]).
Macfarlan JA then considered the authorities concerning post-contract employment restraints and franchising restraints. Relevantly, for present purposes, his Honour distinguished Smith, Dyno-Rod and Chipsaway on the basis of the different factual circumstances in those cases.
In relation to Smith, Macfarlan JA noted at [85] that Austin J had identified at 722 two legitimate interests which the post-contract restraint sought to protect as being first "an interest in protecting the patronage built up through the operation at the franchise, which may be lost if the franchisee is permitted to compete without restriction" and second "an interest in preserving the confidentiality of confidential information provided to the franchisee, which could be used by the Franchisee to compete with the Franchisor if there was no restraint". His Honour said that Blockbuster did not have an interest of the first type to protect for the reason given at [68] above and while Blockbuster had a legitimate interest of the second type, this was protected by the other provisions of the franchise agreements in that case. The second type of interest is not presently relevant, but the first one is.
The first type of interest identified by Austin J is a customer connection with the franchisor built up through the operation of the franchise. There is evidence to support such a customer connection here because the Franchisor conducts marketing arrangements for all its franchisees and, as noted above, a significant proportion of the executory contracts recorded by RBME/T & M Pools at the time of the hearing resulted from "leads" generated by the Franchisor. Further, the Franchisor maintains a call centre which actual or potential customers may contact and there is evidence that particular customers who entered into contracts with T & M Pools during the term of each Franchise Agreement had been contacting the Franchisor's call centre to indicate concerns about the new "non-Narellan" pool which was to be installed under their contract. This evidence indicates that there is a personal connection between the Franchisor and the customers of a franchisee during the operation of the Franchise Agreement which may be lost if the franchisee is permitted to compete without restriction following termination of the Franchise Agreement.
Macfarlan JA distinguished Dyno-Rod and Chipsaway on two grounds. First, his Honour noted that Neuberger J in Dyno-Rod had said that the franchise agreement was closer to a sale of business agreement than an employment contract because the agreement provided that the goodwill generated by the franchisee would ultimately be that of the franchisor, although the franchisee was to have the benefit of it during the term of the agreement. His Honour said that the same could not be said of Blockbuster's position because it had not exercised the option to purchase Karioi's goodwill and Blockbuster did not itself have or acquire any significant goodwill in the businesses beyond that which was attached to the Blockbuster brand. In my view, cl 5.8 of the Franchise Agreement more closely aligns this case to Dyno-Rod rather than to BB Australia.
The second basis upon which Macfarlan JA distinguished Dyno-Rod was as follows: "[91] In the present case there is, in contrast, no evidence and no basis for an inference, that reasonable people in the position of the parties would have contemplated that by reason of Karioi having acted as a Blockbuster franchisee (rather than by reason of its entitlement to continue to operate businesses in the existing locations), any of [Karioi or its two directors] would have a competitive advantage over replacement franchisees appointed by Blockbuster."
This passage is consistent with the observation made in Peart Stevenson that a post-contract restraint on a former franchisee will not be justified unless there is a benefit to the franchisor from the restraint beyond merely restraining competition from that former franchisee. In the present case there is both evidence and the basis for an inference that the outgoing franchisee would have a competitive advantage over the incoming franchisee. First, the Franchisor is required to conduct and the franchisee is required to attend training as to the method and system of marketing, supplying and installing the pools and products. In addition, it is clear from the evidence as to the process by which contracts with customers are entered into and performed that it involves some complexity. It may be inferred that reasonable people in the position of the parties at the time of commencement of each Franchise Agreement would anticipate that an outgoing franchisee would have a competitive advantage over a replacement franchisee through the training and experience gained through operation of the Franchise Agreement in relation to the supply and installation process. There is a significant difference, in terms of time, effort and complexity, between the business of hiring out videos and DVDs on the one hand and the supply and installation of inground swimming pools on the other.
Second, Mr Baily, a director of each plaintiff, gave evidence that (a) the restraint period is critical to the process of recruiting a new franchisee because it provides the new franchisee with an opportunity to establish their business in the Territories; (b) that while the recruitment process had commenced it will be more difficult due to the proceedings and the Franchisor will be forced to accept a reduced "sale price" for the two Territories if the restraint is not enforceable; and (c) one potential new franchisee had indicated that it would not engage in discussions until the outcome of the proceedings was known. Mr Baily was not cross-examined.
Macfarlan JA concluded as follows: "[97] In assessing in the present case the parties' expectations as to the ability of Karioi to compete with Blockbuster (or incoming franchisees of it) after the conclusion of the agreements, one has to assume that Karioi would not be utilising any aspect of the Blockbuster brand (because the agreements prohibited it from so doing). One has also to disregard any competitive advantage Karioi would obtain from utilising the existing store locations as for reasons I have sought to explain above in the circumstances that occurred the effect of the agreements was that that advantage, which Karioi had had prior to the inception of the agreements, was to remain with Karioi. Likewise, one has, for reasons I have given, to assume that Karioi cannot use confidential information obtained from Blockbuster to its competitive advantage. [98] Leaving these three considerations aside, the evidence does not indicate that at the date of the agreements reasonable people in the position of the parties would have contemplated that for any other reason Karioi, by reason of its operations under the agreements, would acquire a competitive advantage over any replacement franchisees that Blockbuster appointed. Nor does the evidence suggest that that in fact occurred. [99] An obvious question to be asked in this context is whether, by reason of its Blockbuster franchise operations, Karioi would have been expected to acquire significant customer connections which it could utilise after the agreements concluded. For reasons I have given, that was not the case if the three matters that I mentioned are disregarded."
In relation to [97], the first and third sentences apply here, but not the second which relates to the particular facts of that case. The observation in [98] does not apply here - the present case is factually different from BB Australia in that, unlike the circumstances of a store hiring out DVDs and videos, there is a basis in the evidence as explained above for at least an inference that the franchisee would acquire under the term of the Franchise Agreement a competitive advantage over any replacement franchisee that the Franchisor appointed. In relation to [99], the answer is yes given the prospect of executory contracts still to be performed at the time of expiry of each Franchise Agreement which would involve the franchisee continuing to exploit the Franchisor's goodwill which it was required to give up under cl 5.8 of the Franchise Agreement.
Finally, I note that in BB Australia, the court did not conclude that a franchisor does not have a legitimate interest of the kind referred to at [55] above which might be protected by a post-contract restraint. Rather, it was concluded that, in the particular circumstances of that case, Blockbuster could not establish that it had such a legitimate interest.

Serious question to be tried

At the final hearing, the plaintiffs will seek injunctive relief and damages or alternatively an account of profits. For present purposes, what is relevant is that the final injunctive relief will seek to enforce the restraint in cl 12.5(b) of the Franchise Agreements against Tim and Matthew being engaged in a business similar to the Business within the Territory the subject of each Franchise Agreement, soliciting clients of the Business or otherwise marketing similar products or pools to those of the plaintiffs within the Territory the subject of each Franchise Agreement.
The defendants put forward essentially five reasons why the court should find that there is no serious question to be tried.

(a) No identifiable proprietary interest protected by the restraints

First, the defendants submitted that there is no identifiable legitimate proprietary interest protected by the restraints and as their primary purpose appears to be a mere restraint on competition, they are prima facie void. In particular, the defendants contended that a customer's pool purchase is a "one off" transaction so that there is little or no continued customer loyalty to be protected by the restraint. It was also contended that the present case is indistinguishable from BB Australia.
In my opinion, there are two legitimate business interests capable of protection by cl 12.5(b) of the Franchise Agreement. The first is preventing the outgoing franchisee from competing with an incoming franchisee for a reasonable period to allow the Franchisor to exploit its goodwill to recruit a new franchisee. In so far as this legitimate interest is based on the need for a benefit to the Franchisor beyond merely restraining competition from the outgoing franchisee, such a benefit does exist in the present case in that the outgoing franchisee would have a competitive advantage over the incoming franchisee: see [76]-[77] above. In my view, this is a basis for distinguishing BB Australia because it brings the matter squarely within the line of authorities including Dyno-Rod and Chipsaway where this legitimate business interest has been recognised.
Second, there is the protection of the relationship with customers to whom an executory contract for the supply of a pool exists at the date of expiry of each Franchise Agreement. That is a customer relationship which the franchisee has agreed not to exploit post termination. There is potentially significant damage to the Franchisor's goodwill if the former franchisee negotiates with customers under contracts which are executory at the time of expiry of the franchise agreement for the supply of a non-Narellan pool to that customer. BB Australia is distinguishable for the reasons given at [73] above.

(b) Whether the contractual restraint applies to the Sydney City Franchise Agreement

As noted above the term of the Sydney City Franchise Agreement expired on 30 April 2021, and RBME continued to operate the franchisees under a monthly licence pursuant to cl 3.4 (set out above).
An issue arises as to whether cl 12.5(b) operates at all to the Sydney City Franchise Agreement. The defendants submitted that it did not for essentially the following reasons: 1. Clause 12.5(b) by its terms does not apply because the 12 month restraint under that clause expired on 31 April 2022. 2. It would not be "appropriate" to incorporate by reference cl 12.5(b) into the terms of the licence under cl 3.4(c)(i) because: 1. the language of the restraint covenants in cl 12.5(b) is explicit in that those covenants are said to continue for a period of 12 (or 6) months following "termination or expiration of this agreement" and delaying the commencement of these restraint periods would be clearly inconsistent with that language; 2. there is no reference to any post-expiration 'licence' period which might postpone the date of commencement of the expiration restraints; and 3. imposing a 12 or 6 month restraint on a one month licence is not "appropriate".
In my opinion the better view is that cl 3.4(c)(i) on its proper construction does import cl 12.5(b) as one of the terms of the continuing monthly licence.
The construction of cl 3.4(c) requires two questions to be addressed: first, what is the scope of the incorporation imported by the words "as appropriate" and second, the meaning to be given to the incorporated terms: Doggett v Commonwealth Bank of Australia [2015] VSCA 351; 47 VR 302 at [122] (Doggett); P Herzfeld and T Prince, Interpretation (2nd ed, 2020, Thomson Reuters) at [23.40]-[23.90].
As to the first question, the ordinary meaning of "appropriate", is "suitable or fitting for a particular purpose, person, occasion etc" (Macquarie Dictionary). Guidance as to width of the incorporation indicated by the word "appropriate" can be found in in Doggett where an incorporation clause in a guarantee which limited the incorporation to "relevant" provisions of the Code of Banking Practice was construed as requiring a sufficient connection between the contract in question and the clause or clauses of the other document sought to be incorporated: see Doggett at [135]-[136]. Here the connection between cl 3.4 and cl 12.5 (b) is strong. Clause 3.4 is, in effect allowing for the extension of the franchise agreement beyond its expiry on a temporary basis (as the further licence can be terminated on a month's notice). Treating cl 12.5(b) as one of the terms required to be incorporated by the word "appropriate" reflects a business-like interpretation of the agreement [6] , as it would make no commercial sense for the restraint in cl 12.5(b) to cease to operate during the period that the monthly licence is in operation particularly where, as here, that monthly licence extends for 12 months thereby negating cl 12.5(b) unless it is incorporated by reference into the monthly licence.
As to the second question, cl 12.5(b) can sensibly operate as a restraint which applies for 12 months from the date of expiry of the agreement arising under cl 3.4(c).
The court was not directed to any authorities dealing with this issue. However, it may be noted that the issue has been addressed in three UK cases, The Flat Roof Co Ltd v Bowden [2009] EWHC 2894 (Ch), SJD Group Ltd v. KJM (Scotland) Ltd [2010] CSOH 13 and PSG Franchising Ltd v Lydia Darby Ltd [2012] EWHC 3707. It was held by Sir John Lindsay in Flat Roof that post-termination restrictive covenants in a franchise agreement do not ordinarily extend beyond their contractual expiry dates when the parties continue the franchise informally after expiry of its contractual term. The contrary conclusion was reached by Lord Glennie in SJD Group Ltd. In the later decision of PSG Franchising, Males J preferred the approach of Lord Glennie and said: "53. There is no evidence before me that the decision in Flat Roof represents a widely shared understanding of the legal position generally held by those concerned in the franchising industry. The text books to which I have referred do not support any such conclusion and suggest, if anything, that the position is still open. I do not accept, therefore, that the law as stated in Flat Roof forms part of the background to the deed of surrender. 54. Further, I am with respect inclined to doubt whether the decision is correct and to prefer the analysis of Lord Glennie. It seems to me that if the parties continue to operate a franchise after the expiry of the contractual term, the likely inference is that they intend their relationship to continue to be governed by the terms of their original contract. If not, it is hard to see on what basis they are continuing. To say, as the defendants do, that the "franchise-at-will" is on the terms of some but not all of the original contract seems productive of great uncertainty which is not a very commercial approach, while the objection to restrictive covenants stated by Sir John Lindsay at [17] in Flat Roof that they are "inherently contrary to public policy" seems to me with respect to have only limited force. If, as in the present case, the restrictions in question constitute a reasonable protection of a legitimate business interest, this objection to them falls away, while if they are unreasonable they will be void and unenforceable in any event."

Third, the defendants point to the fact that there is no mechanism or requirement in the Franchise Agreement for the novation of the franchisee's customer contracts to the Franchisor (or its nominee) on expiry of the agreement. The defendants submitted that the inference was that a franchisee was entitled to perform those contracts, particularly as failure to do so would potentially injure the Franchisor's brand. I understood the relevance of this submission to be that it sought to undermine the plaintiffs' suggestion that cl 12.5(b) protected a legitimate business interest of the Franchisor following termination.
I agree that the Franchise Agreement does not expressly deal with this situation, but it does provide within it a mechanism for the executory contracts to be performed through the monthly licence under cl 5.4. Consequently, any supposed lacuna in the Franchise Agreement is more apparent than real and importantly does not support the submission that the Franchisor has no legitimate interest to protect by cl 12.5(b). To the contrary, reliance on the combination of cl 5.4 and cl 12.5(b) to allow the completion of executory contracts post expiry of the term gives a more sensible outcome which is consistent with the purpose of cl 5.8.

(d) Different considerations apply to Tim and Matthew compared to RBME

Fourth, the defendants contended that different considerations applied to the post-contract restraint against Tim and Matthew and in particular the public policy against restraining the conduct of individuals is stronger. Further, it was said that the plaintiffs' evidence did not disclose what proprietary interests are sought to be protected by the restraints relating to Tim or Matthew being involved in a competitive business.
In my view, the legitimate business interest which justifies the post-contract restraint against RBME is the same as the one that applies for Tim and Matthew given that they have at all relevant times been the sole Nominated Managers of RBME.

(e) Whether cl 12.5(b) is merely "a brass plate" clause

Fifth, the defendants submitted that it is unclear whether cl 12.5(b) is a complete prohibition on Tim and Matthew engaging in any business within the franchise territory or is to be construed as a mere "brass plate" clause, i.e. one which would permit Tim and Matthew to have their business premises outside the franchise territory and to make "house calls" from time to time within the franchise territory. Reference was made to Lu v Lim (1993) 30 NSWLR 332 at 334 and Raine & Horne Pty Ltd v Adacol Pty Ltd [2006] NSWSC 36 at [35]-[38].
In my view, those cases do not assist with the construction of cl 12.5(b)(i). That provision is clear in precluding each covenantor from being engaged in any business within the franchised territory regardless of where the business premises from which that business operates is located. It is also relevant that the nature of the franchise business makes the location of the franchisee's business premises largely irrelevant, as the focus is on the place where the swimming pool is to be installed (the customer's home) rather than the premises from which the franchisee conducts its business.

(f) Conclusion

In my opinion the plaintiffs have established that there is a serious question to be tried, i.e., a prima facie case that the post-contract restraint in cl 12.5(b) is enforceable against the first, second and third defendants. My reasons are as follows. 1. Looking at the matter at the time of entering into the Franchise Agreements, there were two legitimate interests for which cl 12.5(b) could provide protection, both of which relate to the Franchisor's goodwill. They are first, providing the franchisee with sufficient time to recruit a replacement franchisee free of the competition of the outgoing franchisor and, second, maintaining the customer relationship under existing contracts entered into by the outgoing franchisee prior to the expiry of the term but still to be performed. 2. While cl 12.5(b) includes both a covenant not to compete as well as a covenant not to solicit clients, this is not a case where the non-solicitation of clients of the business offers sufficient protection for the legitimate business interest protected by the restraint. 3. The restraint in cl 12.5(b) is reasonable in terms of area (being the same area as the Territory to which the franchise applied) and term. In relation to term, a period of 12 months seems a reasonable period to enable a replacement franchisee to be recruited and trained to conduct the franchise business. While each case turns on its own facts, I note that this conclusion as to area and term is consistent with the decisions in Dyno-Rod, Peart Stevenson, Chipsaway and Smith. 4. In light of the acceptance by the plaintiffs for the purposes of the interlocutory hearing that the fourth defendant was not a party to the Franchise Agreements, no basis has been made out for an interlocutory injunction against the fourth defendant.

Balance of convenience

This is a case where the plaintiffs' entitlement to ultimate relief is uncertain and the task of the court is to determine what course is best calculated to achieve justice between the parties in the circumstances of the particular case pending the resolution of the uncertainty. The relevant test was stated by McLelland J, as his Honour then was, in Kolback at 535: "Where a plaintiff's entitlement to ultimate relief is uncertain, the Court, in deciding to grant or refuse an interlocutory injunction, must consider what course is best calculated to achieve justice between the parties in the circumstances of the particular case, pending the resolution of the uncertainty, bearing in mind the consequences to the defendant of the grant of an injunction in support of relief to which the plaintiff may ultimately be held not to be entitled, and the consequences to the plaintiff of the refusal of an injunction in support of relief to which the plaintiff may ultimately be held to be entitled …".
This involves analysing all the circumstances of the case to see whether, considering the balance of convenience and hardship, the court should exercise its discretion by declining to issue an interlocutory injunction: SAI Global at [103]. In HiTech at [49], Ward CJ in Eq (as her Honour then was) summarised the matters to be taken into account as follows: "[49] As to the balance of convenience, one must balance the hardship that would be suffered by the respective parties if the injunction were, or were not, to be granted … Some of the factors relevant to the assessment of the balance of convenience are: inadequacy of damages; the right to a livelihood; delay; impact on third parties; whether the employee was warned and went into the position with "eyes wide open"; whether any hardship that would be visited on the defendant has come about because he or she is the author of his or her own misfortune; the strength of the case; and any undertakings that have been given."
I will consider each of the matters referred to by her Honour in turn.
In relation to the inadequacy of damages, it is rarely that damages will be considered to be an adequate remedy where, as here, a negative covenant is sought to be enforced: HiTech at [50] and [111]. However, any potential risk that damages will be an inadequate remedy will not be determinative and, as illustrated by HiTech itself, at the interlocutory stage it is simply one of the matters to be considered to determine the course best calculated to achieve justice between the parties up to the determination of the plaintiff's claim for final relief.
The right to a livelihood and hardship to the defendant can be dealt with together. Two principal matters arise. First, the restraints in cl 12.5(b) do not prevent the defendants from being engaged in a pool supply and installation business outside the two territories governed by the Franchise Agreements. While those two areas are significant in size, there are many other significant parts of the Sydney region not covered by them (including the territories within the Franchisor's franchise network known as "Southern Sydney", "Hills District" and "Parramatta-Blacktown") where the defendants would be unconstrained. The restraints therefore do not deprive the defendants of their livelihood.
Further, the defendants were well aware prior to expiry of the Franchise Agreements that the Franchisor would enforce the restraints and so were in a position, had they chosen to do so, to establish a plan for the conduct of their business outside the Territories until the 12-month period of the restraint expired.
Second, the defendants contend that the effect of an interlocutory injunction against Tim and Matthew being involved in T & M Pools for 12 months would be the same as restraining T & M Pools from performing the outstanding executory contracts with customers with the likely consequence that it would become immediately insolvent. However, the proposal set out below to accommodate the potential prejudice to those customers under the outstanding contracts accommodates this potential prejudice to T & M Pools.
In relation to delay, the plaintiffs commenced these proceedings on 9 June 2022 which is shortly after the expiry of the extended term of each Franchise Agreement (31 May 2022). In early June, there was correspondence between the solicitors for the parties in which the plaintiffs sought undertakings from Tim and Matthew that they would abide by the post-contract restraints in cl 12.5(b) and this was rejected by them, through their solicitors, on 8 June 2022. The plaintiffs commenced proceedings the next day. In my view there was no material delay.
In relation to impact on third parties, there are two groups of third parties to be considered. The first is the customers of T & M Pools under executory contracts existing at the date of expiry of the Franchise Agreements which are yet to be performed. Those customers have existing contractual rights against T & M Pools which they are entitled to require T & M Pools to perform. The appropriate course in my view is that an interlocutory injunction would need to exclude from its scope such contracts so that T & M Pools is not precluded from performing those contracts as that would prejudice innocent third parties. Of course, the performance of those contracts will potentially involve a breach of the Franchise Agreement by any of RBME, Tim or Matthew. That is a matter to be determined at the final hearing and, if successful, the Franchisor's remedy will be damages or an account of profits.
Second, T & M Pools has a number of contractors which it engages for the purposes of performing its obligations under contracts with customers. Any potential prejudice suffered by these persons will potentially be alleviated by the carve out referred to in the previous paragraph and from the fact that T & M Pools is free to conduct its business anywhere except the two Territories the subject of the Franchise Agreements.
As to whether the defendant was warned, it is clear that it was (see [39] above) and hence went into this dispute with its eyes wide open.
Next, it is necessary to consider the strength of the plaintiffs' case and any undertakings proffered by the defendants which are related matters. In relation to the strength of the plaintiff's case, this has two aspects. First, there is a question as to the enforceability of the post-contract restraint in cl 12.5(b). In my view the plaintiffs will have good prospects of establishing at the final hearing that the restraint does not go further than is reasonably necessary to protect the first plaintiff's legitimate business interests in respect of its goodwill, at least for a period of 6 months. Second, there is the question whether the post-contract restraint is incorporated by reference into the monthly licence under cl 3.4 of the Sydney City Franchise Agreement. In my opinion, the better view is that it is.
In relation to undertakings, the defendants have provided undertakings to the court that they will not use the plaintiffs' confidential information but these undertakings do not address the post-contract restraint and the first defendant has given to the court an undertaking substantially in the terms of cl 12.5(b).
Taking into account the above considerations, I have concluded that the prejudice which the plaintiffs will suffer if it is subsequently found that an interlocutory injunction should have been granted to restrain the first, second and third defendants from being engaged in a competing business within the Territory the subject of each Franchise Agreement outweighs the prejudice which the defendants will suffer if it is subsequently found that an injunction in that form had wrongly been granted at this stage.
For the above reasons, I consider that an injunction substantially in the form of prayer 1 of the summons should be granted, except that there should be a carve out for the contracts referred to in paragraph [108]. The costs of the plaintiffs' application for interlocutory relief should be costs in the cause.
The court therefore orders: 1. Direct the parties to bring in short minutes of order to give effect to these reasons. 2. List the proceedings before me tomorrow at 11am for the parties to bring in short minutes of order. 3. Refer the matter to the Expedition List for directions on 29 July 2022. 4. Grant liberty to apply.

Endnotes

These principles were confirmed in Commissioner of State Revenue (WA) v Placer Dome Inc [2018] HCA 59; (2018) 265 CLR 585 at [68]-[76], [91].
JH Coles Pty Ltd v Need [1934] AC 82 at 87, 89; Favotto Family Restaurants Pty Ltd v Chief Commissioner of State Revenue [2020] NSWSC 120 at [170]-[171].
Dyno-Rod Plc v Reeve (1999) FSR 148 at 153.
Okotoks Ltd v Fine & Country Ltd [2013] EWCA Civ 672 at [57]-[58]; C Wadlow, Wadlow on the Law of Passing Off (6th ed, 2021, Sweet & Maxwell) at [7-201]-[7-202]; see also KA & C Smith Pty Ltd v Ward (1998) 45 NSWLR 702 at 722 ("the franchisor also has an "interest" in the customers [of the franchisee] since they are attracted to the business as a franchise business").
Dyno-Rod Plc v Reeve [1999] FSR 148 at 155-157; Peart Stevenson Associates Ltd v Holland [2008] EWHC 1868 at [43]-[44]; Chipsaway International Ltd v Kerr [2009] EWCA Civ 320 at [22]-[24]; KA & C Smith Pty Ltd v Ward (1998) 45 NSWLR 702 at 723-724; PSG Franchising Ltd v Lydia Darby Ltd [2012] EWHC 3707 at [35] and [44]-[45]; Carewatch Care Services Ltd v Focus Caring Services Ltd [2014] EWHC 2313 at [128]-[131]; JD Heydon, The Restraint of Trade Doctrine at page 100.
Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd (2015) 256 CLR 104; [2015] HCA 37 at [51].

Amendments 25 July 2022 - 25 July 2022 - Minor typographical amendments. [96] - "directors" to "Nominated Managers". DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 25 July 2022

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