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YOUR RESTRICTIVE COVENANTS; do they mean what you think they mean?

Published: 28th May 2009

If a restrictive covenant does not make sense, what can/will the court do - will it treat the covenant as ineffective or will it re-write the covenant to meet what it believes was the commercial intention of the parties?

In the recent case of CHIPSAWAY INTERNATIONAL LTD v ERROL KERR the Court of Appeal was faced with this question.

The claimant, ("CIL"), ran a franchised business for the repair of dents and scratches to the bodywork and bumpers of vehicles, and also supplied the paints and other goods that its franchisees used. The franchisees were also allowed to use the name "ChipsAway", (and were required to use it on stationery and advertising signs). CIL granted franchises in a number of geographical areas.

The defendant, ("EK"), became one of CIL's franchisees in an area in November 2002. The franchise agreement was initially for a period of 5 years. EK also took a 5 year lease of premises for this purpose. When the lease expired EK renewed it, but told CIL that he did not want to renew the franchise agreement. However, EK then continued to operate a similar vehicle repair business from the premises, but he did not use any CIL products or paints, or use the "ChipsAway" name.

CIL issued proceedings claiming that in continuing to provide this repair service in this geographical area EK was in breach of his restrictive covenants in the franchise agreement, notwithstanding that at that time CIL had not replaced EK with another franchisee in the area and was not actively looking to do so.

Problems arose because of a failure to draft the restrictive covenants in the franchise agreement to complement the key provisions in the 'Definitions' section.

'The Franchisee' - was EK
'Business' - "The provision by the 'Franchisee' of a service to the customers repairing damage to vehicle paintwork, and to other areas of vehicles, within the Territory using the ChipsAway system ..."
'Territory' - the Banbury area.

The post-termination restrictive covenant read, (in part): "For a period of 12 months following termination of this agreement for whatever reason ... the Franchisee will not:
(a) without ChipsAway's prior written consent be engaged in any capacity in any business which competes with the Business (as carried on at the date of termination) within the Territory;

The problem was that whoever drafted the sub-clause (a) had overlooked the fact that the definition of 'Business' referred to the provision of the relevant services by EK. Thus, the covenant prevented EK from competing with his own business as carried on at the time of termination of the franchise agreement.

The trial judge thought that this was clearly 'nonsense', and held that it was necessary to "depart from the grammatical meaning to a limited extent in order to produce a result which does work and which accords with the concepts underlying the unsatisfactory wording". The trial judge then redrafted the covenant in such a way that it only restrained EK from operating in the area if there was also a CIL franchisee in the area as well. It therefore followed that as there was no new franchisee in place at the material time EK was not in breach of the restrictive covenant.

CIL appealed.

The Court of Appeal, ("CoA"), agreed with the trial judge that the sub-clause was defective - EK could not compete with himself - and that the court needed to do some redrafting. The CoA said that the rewriting required was that which involved: "The minimum changes necessary to achieve a sensible meaning and which (gives) effect to the commercial purpose of the clause."

The CoA disagreed with the judge's interpretation and held that the original clause was neither appropriate to apply to a post-termination business, nor appropriate for a business carried on by someone other than EK, and held that the trial judge's interpretation failed to recognise the true commercial purpose of the clause - namely the protection of CIL's "goodwill" built up in the area by EK's use of CIL's name and branding during the term of the franchise agreement. This was a potentially valuable asset in the hands of EK so long as he continued to trade in the area, and in the hands of CIL at the termination of the franchise agreement.

The CoA accepted CIL's argument that its interest in the "goodwill" was vulnerable to competition from EK. He was a former franchisee with knowledge of the area and the customers in the area, and that the commercial purpose of the covenant post-termination was to prevent EK from competing in the area for a period of time to enable CIL to exploit the "goodwill" that EK had built up, most obviously by recruiting a replacement franchisee for the same area.

Accordingly the defective clause should be re-written to prevent EK from competing in the area by providing the type of service that was being provided by and pursuant to the franchisee agreement between CIL and EK at the time of its termination. This meant that EK was in breach of the restrictive covenant and an injunction was granted to restrain the breach.

Was the covenant, as re-written, an unreasonable restraint of trade?
This point did not arise. EK did not pursue this issue on appeal.

The case further illustrates the increasing readiness of the courts to rewrite a badly drawn restrictive covenant. However, this should not lead to complacency and businesses should take care to ensure that their contractual terms afford them the protection that they believe that they do, and require.

If this raises any questions for your organisation please contact Craig Blakemore or Duncan McAllister in Liverpool: 0151 236 8989 or Graeme Jump or Josh Conroy in Manchester: 0161 214 0500.