On April 23, 2024, the U.S. Federal Trade Commission (FTC) announced that it is “banning noncompetes” in the United States. In its announcement, the FTC quotes Chair Lina M. Khan as saying, “The FTC’s final rule to ban noncompetes will ensure Americans have the freedom to pursue a new job, start a new business, or bring a new idea to market.” While this may initially sound like good news for franchisees, the FTC’s “ban” on noncompetes isn’t as broad as it seems—as national franchise attorney Jeffrey M. Goldstein explains.
The FTC Isn’t Actually “Banning” Noncompetes
Despite what the FTC says about its new noncompete rule on its website, the FTC isn’t actually “banning” noncompetes. The new rule is much more limited in scope, and it’s a bit strange that the FTC is using such broad—and arguably misleading—language to describe what it has done.
So, what has the FTC done? The FTC has adopted a final rule that prohibits the enforcement of noncompete clauses in many (but not all) employment contracts. Specifically, the final rule states that noncompetes that restrict “workers” will not be enforceable once the final rule takes effect later this year.
As the final rule makes clear, “workers” do not include franchisees:
“[T]he final rule does not cover franchisor/franchisee non-competes. Non-competes used in the context of franchisor/franchisee relationships remain subject to State common law and Federal and State antitrust laws, including section 5 of the FTC Act.”
In short, despite the FTC’s purported “ban” on noncompetes, noncompete clauses in franchise agreements remain unaffected by the FTC’s new rule. This means that franchisees must comply with their franchise agreements’ noncompete clauses (unless these clauses are unenforceable under other applicable law), and prospective franchisees must carefully consider franchisors’ noncompete clauses during the franchise agreement negotiation process.
When is a Noncompete Clause in a Franchise Agreement Unenforceable?
In light of the limited scope of the FTC’s noncompete “ban,” noncompetes remain enforceable—in most cases. Most states allow noncompetes between commercial parties, and when it comes to noncompete enforcement in the franchisor-franchisee context, federal law rarely comes into play.
But, this doesn’t mean that all franchise noncompetes are enforceable. For example, California has effectively banned noncompetes. Additionally, even when state laws allow for noncompete enforcement (and a state’s policy favors use of noncompetes to protect legitimate business interests), there are limits. Generally, noncompetes must be reasonable as to both geographic scope and duration, and substantively, they must be no broader than necessary to protect the legitimate business interests involved.
With that said, a franchise agreement is considered to be an arm’s length transaction, and this means that courts will generally defer to the parties’ judgment. Franchisors (and their attorneys) have also honed their noncompete clauses over the years in an effort to provide maximum protection without crossing the line. As a result, noncompete clauses in franchise agreements tend to be fully enforceable as written—and this is a factor that prospective franchisees need to consider during the buying process.
Key Considerations When Negotiating a Franchise Agreement’s Noncompete Clause
Like most franchise agreement provisions, franchisors will typically try to get franchisees to accept their noncompete clauses as written. But, this doesn’t mean that prospective franchisees should forego negotiations. Negotiating reasonable protections into your franchise agreement is important; and, since most franchisors know their franchise agreements are heavily one-sided, good ones will be willing to consider reasonable modifications in most cases.
Here are some key considerations for negotiating the noncompete clause in a franchise agreement:
1. Focus On Your Specific Circumstances
In many cases, the most effective way to negotiate a franchise agreement’s noncompete clause will be by focusing on your specific circumstances. For example, let’s say you are buying a gym franchise and your background is in personal training. If you are negotiating a franchise agreement that prohibits you from engaging in “any business in the fitness industry” for the next two or three years, you may want to try to negotiate a carveout for providing personal training services. That way, even though you might not be able to open a competing gym once your franchise is over, you will still be able to make a living off of your education, background and personal experience.
2. Focus on the Relevant Law
When negotiating a franchise agreement’s noncompete clause, it is also important to focus on the relevant law. If your state’s law restricts the scope or duration of noncompetes, you should make sure that your franchise agreement’s noncomplete clause is no broader or longer than the law allows. An experienced franchise attorney can help you understand what your state does and doesn’t allow.
3. Don’t Rely on Unenforceability
If your franchise agreement’s noncompete clause doesn’t comply with your state’s law, you might think that the best approach would be to leave it alone and then rely on its unenforceability after your franchise agreement expires (or your franchisor terminates your franchise for cause). But, this generally isn’t the case.
Why?
First, some states allow for “blue penciling,” which means that the courts can revise noncompete clauses to make them legally enforceable. Second, even if you don’t live in a “blue pencil” state, there is no guarantee that a court or arbitration panel will rule in your favor. Additionally, even if you have clear grounds to challenge the enforceability of your noncompete, doing so will not be cheap. As a result, the better approach is likely to be negotiating a reasonable noncompete clause that you are willing to accept post-expiration or post-termination.
Contact National Franchise Attorney Jeffrey M. Goldstein
Do you have questions about how to protect yourself during the franchise agreement negotiation process? If so, national franchise attorney Jeffrey M. Goldstein can explain everything you need to know, and if you’d like, he can negotiate your franchise agreement on your behalf. To learn more in a free and confidential consultation, give us a call at 202-293-3947 or tell us how we can get in touch online today.
