Post-Term Covenants and Whether They Hold

Every franchise agreement contains two restrictive covenants and they are frequently confused. The in-term covenant prohibits the franchisee from operating a competing business while the franchise is running. The post-term covenant prohibits it afterward, for a stated period and within a stated area. The first is routinely enforced and rarely litigated. The second is the one that decides whether a departing franchisee has a business or a waiting period.

The shape of a typical restriction

A post-term covenant ordinarily prohibits the former franchisee, its owners, and often their immediate families from owning, operating, advising, or holding an interest in a competing business for a defined period after expiry or termination. The period is commonly one to three years. The area is usually described in layers: the former premises, a radius around it, the former territory, and a radius around any other outlet in the system.

That last layer is what makes some covenants unworkable. In a dense system, a radius around every other outlet can cover an entire metropolitan area, which converts a restriction on competing near the old site into a prohibition on working in the industry anywhere the franchisee lives. Courts notice the difference, and the outcome frequently turns on whether the franchisor drafted for its actual interest or for the maximum area it could describe.

Two companions travel with the covenant. A non-solicitation clause bars approaching customers served during the term, which is easier to justify than a general trading prohibition because it targets the goodwill the franchisee acquired through the brand. A confidentiality clause protects the manual, recipes, methods, and customer data, and it is generally enforceable indefinitely as to genuine trade secrets regardless of the covenant's fate.

How courts test the covenant

In most states the covenant is examined for reasonableness on three axes: duration, geographic scope, and the range of activity prohibited, each measured against the legitimate interest the franchisor is protecting. That interest is usually described as the goodwill associated with the marks, the system's confidential methods, and the ability to place a successor franchisee in the market without competing against the previous one.

Franchise covenants are generally reviewed under a standard closer to the sale of a business than to employment. The reasoning is that the franchisee is a commercial party that purchased access to goodwill and agreed to return it, rather than an employee with unequal bargaining power. That characterization matters, because employment covenants attract far more suspicion in most jurisdictions. Where a court instead sees a franchisee whose position resembled employment, an owner-operator working behind the counter, the analysis tightens.

Practical outcomes cluster. Restrictions tied to the former premises and the former territory, for a period of one to two years, in the same line of business, are frequently enforced. Restrictions extending across a state, covering businesses the franchisee never operated, or running for extended periods are frequently cut down or refused. The most common defect is not duration but scope of activity, where the drafting prohibits any business that competes in any respect rather than the business the franchisee actually ran.

Where the covenant is void whatever it says

A small group of states has legislated against restraints on trade in general terms. The best known provision declares void every contract by which anyone is restrained from engaging in a lawful profession, trade, or business, subject to narrow statutory exceptions for the sale of the goodwill of a business and for the dissolution of a partnership or company. Franchise covenants have generally not fit within those exceptions, because the franchisee is not selling goodwill back so much as ceasing to use a license.

Two other states have statutes in similar terms, and several more limit covenants by income threshold, notice requirements, or a requirement of independent consideration. Franchisors respond by relying on confidentiality and non-solicitation clauses, which survive in most of these states, and by pursuing trademark and trade dress claims where the former franchisee continues to use anything associated with the system.

Blue pencil, reformation and total failure

Where a covenant is overbroad, jurisdictions take one of three positions. Some will strike offending words if the remainder reads sensibly without them, an approach that rewards drafting in severable clauses and punishes a single sweeping sentence. Some will reform the covenant to what is reasonable, rewriting the period or the radius. Some will refuse to save it at all, holding that a party that drafted an unlawful restraint should not receive a court-drafted substitute.

The differences are consequential. In a reformation state, a franchisor loses little by overreaching. In a state that refuses to reform, the same drafting produces no restriction whatever. Multi-state systems accordingly draft in tiers, with alternative periods and radii stated as separate covenants, and add a savings clause. Whether tiered drafting survives depends on the jurisdiction as well.

The direction of travel

The general movement is against restrictive covenants, though it has reached franchising indirectly. Federal rulemaking aimed at noncompete clauses was framed around employers and workers and expressly did not treat a franchisee as a worker for that purpose, leaving the franchise covenant outside it, and the rule's enforceability has been contested in litigation. State legislatures have moved more directly on a narrower point, prohibiting clauses that stop one franchisee hiring another's employees, after enforcement attention to the effect of such clauses on wages.

For a franchisee planning an exit, three practical points follow. Establish which state's public policy will govern, because that is the first-order question. Distinguish the covenant from the confidentiality and trademark obligations, which usually survive independently and are enforced more readily. And read the covenant together with the rest of the exit machinery, including the notice and cure requirements that govern how the relationship ends, the conditions that would apply to a sale instead of a closure, and the guaranty that continues to bind the owners afterward. Selling the outlet to an approved buyer avoids the covenant question entirely, which is why the covenant is often best addressed long before the term ends.