A Study on Covenants Not to Compete in Franchise Agreements

Many franchise agreements include a covenant not to compete which obligates the franchisee not to operate in another business similar to franchised business within limited time and scope. Because of the absence of uniform statutory franchise covenant law, courts usually determine whether the covenant is enforceable by article 72 or article 247-1 of Taiwan civil code. However, there are indefinite legal concepts in these clauses and need to be interpreted by striking a balance between competing legal interests in each individual case. Standard of reasonableness, the theories of five criteria or three criteria in post-employment covenants not to compete, and a standard exclusive for franchise agreement are some criteria that courts adopt when determining the enforceability of the covenant. There are four basic types of franchise in Taiwan. They are regular chain, franchise chain, authorized chain and voluntary chain. After analyzing different theories and judgements, my research found that standard of reasonableness and legitimacy are common standards for covenants not to compete in all types of franchises. In regular chain, franchise chain, authorized chain, due to the strong control from the franchisor and the dependency of franchisee, the franchisee is similar to an employee and need to be protected. As a result, article 9-1of labor standards law which includes an upper limit of period and compensation payment can be applied to these three types of franchise by analogy. When determining the enforceability of covenants not to compete, legitimacy is the first to be considered. Customer information, Know-How, training for the franchisee, goodwill and maintenance of customer relationship are legitimate business interests in franchise agreements. The standard of reasonableness is the second step. It is hard to define a specific standard for time and scope, but it has to connect to the legitimate business interests when determining the limits of time and scope in different cases. The legitimacy and rationality of covenant not to compete in franchise agreement must be in accordance with different types of franchises and market conditions. As a result, criteria can be formed from case accumulation by judicial authority to enhance the predictability of enforcement and efficiency of contract negotiations. It seems that there will be further reliance by the courts on a case-by-case basis to set forth more precise standards and rules to govern the enforceability of covenants not to compete in franchise agreements.