In May of last year, the Federal Trade Commission (FTC) sought to ban non-compete agreements in most employment contracts. Franchise agreements were an exception. However, before the rule could take effect in September, a federal court vacated the ruling in August, asserting that the FTC lacked the authority to enforce such a regulation.
Following this setback, the FTC promptly filed a notice of appeal with the Fifth Circuit Court of Appeals, keeping the issue in legal limbo.
Franchisors should understand the implications of non-compete agreements is essential. While these clauses serve to protect franchisors’ proprietary interests, trade secrets, and system integrity, they also pose challenges for franchisees, who may perceive them as unfair restrictions on future business opportunities. Franchisees argue that post-term non-competes hinder their ability to leverage their experience and investment after exiting a franchise system, limiting market competition and personal livelihood. Conversely, franchisors maintain that such provisions are necessary to preserve brand integrity, protect franchisees who remain in the system, and safeguard proprietary business models.
NASAA’s Guidance on Franchise Non-Compete Agreements
Amid this ongoing legal and policy debate, on January 27, 2025, the Franchise and Business Opportunities Project Group—part of the North American Securities Administrators Association (NASAA)—issued guidance on post-term non-competes within franchise agreements. See https://www.nasaa.org/wp-content/uploads/2025/01/Post-Term-Non-Compete-Provisions-in-Franchise-Agreements-Should-Be-Reasonable.pdf. Their recommendations address several critical aspects of the franchisor-franchisee relationship:
1. The Uniqueness of Franchise Relationships
- Unlike a traditional buyer-seller transaction, a franchise agreement grants a franchisee the right to operate a business using an established system for a defined period.
- Franchisors grow their brand by leveraging franchisees’ investments rather than solely relying on their own capital.
2. Differing Expectations Between Franchisors and Franchisees
- Franchisors seek to expand their system to strengthen brand value, market reach, and overall profitability.
- Franchisees, as business owners, aim to maximize their autonomy, investment returns, and long-term viability.
3. End-of-Relationship Challenges
- Divergent expectations often become most pronounced at the conclusion of the franchise relationship.
- While franchisors enforce post-termination rights, franchisees may wish to utilize their experience and business acumen in new ventures.
4. What Constitutes a “Reasonable” Post-Term Non-Compete?
NASAA recommends that franchisors craft post-term non-compete agreements that are reasonable and clearly define legitimate business interests. Key considerations include:
- Scope: Restrictions should apply only to competitive businesses directly related to the franchise system, avoiding overly broad limitations.
- Duration: Non-competes should be limited to the time reasonably necessary to protect the franchisor’s business interests. While the appropriate timeframe varies across industries, agreements should avoid excessive restrictions.
- Geographic Limitations: Any territorial restrictions should be as narrow as possible, potentially applying only to a specified radius around the franchise location or other branded outlets.
5. Compliance and Best Practices for Franchisors
Beyond restrictive covenants, franchisors should ensure that franchise agreements require the return of branding assets, including trademarks, trade dress, signage, and domain names, upon termination or expiration.
For in-house attorneys managing franchise agreements, these developments underscore the importance of periodically reviewing non-compete provisions to ensure compliance with evolving legal standards and industry best practices. Given the FTC’s ongoing legal battle and NASAA’s evolving stance, franchisors should consult experienced franchise counsel to assess whether modifications to existing agreements are warranted.
By staying proactive, in-house legal teams can help maintain a fair balance between protecting the franchisor’s business model and allowing former franchisees to pursue future opportunities within reasonable constraints.