Chipsaway International Ltd v Kerr

This is an appeal from the decision of Sir Andrew Park in proceedings brought by the claimant franchisor against the defendant, who was one of its former franchisees, for injunctions to enforce post-term restrictive covenants in a franchise agreement made between the parties on 14 October 2002. The judge found that there had been no breach of the restrictive covenants by the defendant. Whether there had been a breach depended on the proper interpretation of the relevant covenant.

The judge did not go on to decide whether, as contended by the defendant, the covenants were unenforceable as being in unreasonable restraint of trade and contrary to public policy.

In this appeal the claimant says that the judge misinterpreted the relevant restrictive covenant and should have held that the defendant had acted in breach. There is a respondent’s notice by which the defendant says that, if he acted in breach of the covenant, it was unenforceable as being an unreasonable restraint of trade and contrary to public policy, but the defendant has not pursued his respondent’s notice. It follows that the single point that arises on this appeal is as to the true meaning of the relevant restrictive covenant.

The claimant has rights to and know-how in a system, the trade name of which is “ChipsAway”, for filling and restoring damage, typically dents and scratches to the bodywork and bumpers of cars and other vehicles. It is also a supplier of products, particularly paints, used in the system. The claimant does not itself provide a service of repairing scratches, dents and the like: it is a franchising company; it grants franchises in local areas, authorising its franchisees to use the ChipsAway name, paints and other products. It provides to its franchisees instruction, advice and operations manual, and so on.

At the time when the defendant became a ChipsAway franchisee, the claimant used to grant three kinds of franchise: mobile retail franchises, mobile trade franchises and car care centre franchises. On 14 October 2002 the claimant and the defendant entered into the franchise agreement with which these proceedings are concerned. The franchise was a car care centre franchise. It commenced with effect from 11 November 2002 and was for an initial term of five years. On 19 December 2002 the defendant took a five-year lease at 2a Cope Road, Banbury. These premises were his car care centre during the franchise period.

The defendant carried on business as a sole trader using the business name Spectrum Auto Solutions. The franchise agreement required his letter headings, invoices, advertising material, and so on, to feature the name “ChipsAway”, and they did. ChipsAway also had to appear on signs posted at 2a Cope Road, and they did.

The defendant’s lease expired on 18 December 2007. On the following day he renewed the lease for a further five years. On 12 February 2008 he wrote to the claimant saying that he did not wish to renew his franchise. He still carried on business at 2a Cope Road. His business includes providing to customers a service of repairing scratches and dents in the bodywork and bumpers of cars; he does not, however, use any ChipsAway paint or other products, and he does not use a ChipsAway name or manuals.

By proceedings issued on 1 April 2008, the claimant alleged inter alia that by continuing in business in the Banbury area and providing a service of repairing damage to paintwork etc on the vehicles, the defendant was in breach of the restrictive covenants in the franchise agreements. Injunctions were sought. At the time of the hearing before the judge in July 2008, the claimant did not have a franchisee for the postcodes that were covered by the defendant’s franchise under the agreement. There was neither a car care centre franchisee nor a mobile franchisee for what used to be the defendant’s Territory. As the judge put it, it was conceivable that a new franchisee from Banbury area might come forward over the next few months, but the claimant was not specifically seeking to find and recruit one.

Recital D of the agreement provides:

“The Franchisee … wishes to be granted a franchise to use ChipsAway’s business system and format within a defined Territory”

Clause 1 contains definitions which include the following:

“‘Business’ means 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, the Trimfix system and the Intellectual Property and subject to the terms and conditions of this Agreement and the Operations Manual.

….

‘ChipsAway System’ means the unique combination of chemicals and paints which enables the effective and speedy repair of chip damage to vehicle paintwork to be carried out, together with such other services as ChipsAway may stipulate should be made available to Customers during the term of this Agreement and any renewal thereof.

…

‘Customers’ means all customers or potential customers of the Business from time to time.

…

‘Territory’ means the area which is specified in Schedule 4 of this agreement.”

Clause 2 is headed “Grant of a Franchise”. Clause 2.1 provides:

“Chipsaway grants to the Franchisee the right to operate the Business using the ChipsAway System, the Trimfix System, the Intellectual Property, the Know-How and the Operations Manual within the Territory and on the terms and conditions of this Agreement.”

Clauses 21 to 23 deal with various aspects of the termination of franchise agreement.

Clause 22 provides, so far as is material:

“22.1.

After this Agreement has come to an end for any reason, or if it is assigned by the Franchisee, the Franchisee… must...

(b)

immediately provide ChipsAway with a list of all Customers and assign to ChipsAway in such manner as ChipsAway requires the benefit of any existing contracts with Customers…

(h)

enter into and deliver to ChipsAway any other documents which ChipsAway or its legal advisors consider necessary or convenient for the proper termination of this Agreement, and the transfer of the rights under this Agreement to ChipsAway or anyone else nominated by ChipsAway.”

22.3:

“Within 28 days after termination of this Agreement for whatever reason, ChipsAway may give notice of its intention to exercise an option to purchase all the assets of the Business belonging to the Franchisee at an agreed valuation…”

Clause 23 is headed “Restrictions after Termination”; so far as material it provides:

“23.1

For a period of 12 Months following termination of this Agreement for whatever reason for the assignment of the Franchisee’s rights under this Agreement 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 or assignment) within the Territory;

(b)

accept or solicit custom for business which competes with the Business (as carried on at the date of termination or assignment) from any person, firm or company who or which has been a customer of the Business at any time during the 24 Months prior to the termination or assignment of this Agreement.”

The main focus of the judgment is on Clause 23.1(a). The judge said that this clause:

“Appears to say that ‘the Franchisee’ (Mr Kerr) must not be engaged in any business which competes with the provision by the Franchisee (Mr Kerr) of a service of repairing damage to vehicle paintwork.”

That was “nonsense”. In order to avoid this nonsense the judge said 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.”

At [18] the judge said that he had to interpret the “otherwise ineffective phrase” as follows:

“Any business [small b] which competes with a business [small b] which is a successor to or otherwise has the characteristics of the Business [capital B] (as carried on at the date of termination)…”

At [19] the judge asked what Clause 23.1(a) meant when applied to the facts of the case if it was modified in the way that he had described to give it a “workable meaning”. The answer he gave was that for twelve months, from the termination of the franchise, the defendant must not, without the claimant’s consent, be engaged in any capacity in any business:

“which, within what had been the Territory of his franchise, competes with any ChipsAway car centre business carried on from a fixed base at 2a Cope Road or from a fixed base elsewhere in the Banbury area.”

On that basis he concluded that the defendant was not in breach of Clause 23.1(a). His business did not compete with a ChipsAway car centre business in the area. At the present time there was no ChipsAway car centre business in the area, nor was there any other sort of ChipsAway business based in what had been the defendant’s ChipsAway territory. In other words there could be no breach of the covenant, until and unless, within the twelve months’ period, the claimant granted a franchise to a new ChipsAway operator in the area. The words “which competes”:

“…refer to actually competing on the facts as they are, not to the possibility that competing might begin to happen in the future if the facts change.” (See [22])

It was necessary for the business in which the defendant was engaged to compete with the business:

“in the sense of an actual business undertaking. It is not enough for Mr Kerr’s present business to be competing ‘for’ business, in the sense of custom or trade, in the Territory” (See [23])

At [28] the judge said that, even if Clause 23.1(a) did apply, he was not convinced that on the particular facts of the case the covenant would be enforceable, but he did not decide that point. He then considered Clause 23.1(b) and, for the reasons that he gave at [30] and [31], he refused to grant the claimant injunctive relief. There is no appeal against that part of the decision.

The judge rightly recognised that, on a literal interpretation, Clause 23.1(a) made no sense. It made no sense to restrain the defendant from engaging in any business which competed with the provision by the defendant of the services described in the definition of the “Business”. The defendant could not compete with himself; some rewriting of the clause was necessary. In my judgment the rewriting that was required was that which involved the minimum changes necessary to achieve a sensible meaning and which gave effect to the commercial purpose of the clause. On the judge’s rewriting of the clause the defendant is restrained from engaging in any business which competes with the business which is “a successor to or otherwise has the characteristics of” the business in which the defendant was engaged pursuant to the franchise agreement at the date of its termination.

The critical feature of this interpretation is that the clause only bites if, during the twelve months after the date of termination, there is a business actually trading which can be said to be a successor to, or otherwise have the characteristics of, the business in which the defendant was engaged pursuant to the franchise agreement at the date of termination. Even if the commercial purpose of the clause were left out of account, I would not accept the judge’s interpretation. First, the words “the Business (as carried on at the date of termination or assignment)” do not naturally refer to a business being conducted in the period after termination or assignment; they more naturally refer to a business being conducted at the date of termination or assignment. Secondly, the words more naturally refer to the service being provided by the defendant at the date of termination or assignment than to a business being conducted by someone else after the termination or assignment of the agreement.

I cannot accept the submission of Mr Parry that Clause 22 supports the judge’s interpretation. Mr Parry argues that Clause 22.1(b) and (h) and 22.3 show that the parties contemplated that, after the termination of the agreement, the claimant would grant a franchise to a new franchisee in the Territory, and that the purpose of Clause 23.1 was to protect the new franchisee’s business. I accept that Clause 22 contemplates at least the possibility of the grant of a franchise to a successor franchisee. But it seems to me that this sheds no light on the scope and meaning of Clause 23.1. Both the claimant and the new franchisee would have an interest in the success of the new franchisee’s business. One way of promoting that business would be to limit competition of a previous franchisee, and that is the obvious purpose of Clause 23.1.

On linguistic grounds alone, therefore, it seems to me that the meaning contended for by Mr Evans Tovey is to be prepared. This interpretation of the clause is that the defendant would not be engaged in any business within the Territory which competes with the provision of the type of service which was being provided by and pursuant to the agreement at the time of its termination. This meaning gives effect to the important words in parenthesis “as carried on at the date of termination or assignment”, which focus on the business that was being carried on at that date.

But the fundamental objection to the judge’s interpretation is that it does not achieve a sensible commercial purpose. As Mr Evans Tovey points out, during the term of a franchise, goodwill is built up in the franchise territory with the use of a franchisor’s name and branding. Such goodwill is a potentially valuable asset in the hands of the franchisee so long as he continues to trade in the franchise territory, and in the hands of a franchisor at the termination of the franchise agreement. A franchisor’s interest in that goodwill is vulnerable to competition from a former franchisee who has knowledge of the area and experience of dealing with particular groups of customers. The commercial purpose of a post-termination covenant against competition is to prevent the franchisee for a period of time from continuing and competing in his former territory in the same line of business so as to enable the franchisor to exploit the goodwill that he has built up during the term, most obviously by recruiting another franchisee for the same area. See, for example, Prontaprint Plc v Landon Litho Ltd [1987] FSR 315 324, where Whitford J said:

“It is of course apparent that the circumstances of this case differ from those of the sale of a piece of property but they are in my view rather closer to that situation than to the situation as between an employer and an employee. The plaintiffs are in a franchising business. They want to grant franchises and have franchisees up and down the country, and for that purpose they want to ensure that they are in a position to prevent competition against franchisees whom they might appoint by persons who in fact built up their knowledge and interest as franchisees.”

Neuberger J put the point more fully in Dyno-Rod plc v Reeve [1999] FSR 148, 155, where he said:

“The plaintiff is anxious to protect its business within the area. In that connection, now that the [franchise agreement] is determined, the plaintiff wishes it to enter into a new arrangement with a fresh franchisee. The plaintiff’s primary concern in seeking the present injunction is to protect its goodwill in the area and to protect its ability to enter into a fresh arrangement for such incoming franchisee and indeed to find such an incoming franchisee.

As Mr Tritton says, it is not from other drain-cleaning businesses that an incoming franchisee needs protection or, I add, could conceivably be entitled to protection. It is from the plaintiff’s own ex-franchisees an incoming franchisee is entitled to protection, provided that that protection is reasonable. In this case the protection sought and contractually agreed to is for one year and is only within the area.

It is obvious that the plaintiff will be likely, and one would have to judge this at the date of the agreement, to have far greater difficulty in attracting a new franchisee if the ex-franchisee is known as a Dyno Rod franchisee with all the Dyno Rod experience and contacts and is operating in the territory. An ex-franchisee has the benefit of considerable investment by the plaintiff which puts the ex-franchisee in a better position than others. Provided that it is reasonable in terms of the public interest and not unfair to the ex-franchisee in terms of time or area, the plaintiff is entitled in my judgment to ensure that his investments are protected by ensuring that unfair advantage is not taken by an ex-franchisee by for example for instance prematurely determining the franchisee agreement and setting out on his own.”

Both Prontaprint and Dynorod were cases involving claims to enforce covenants that had been entered into by franchisees not to compete following termination of their franchise agreements.

The purpose of Clause 23.1(a), therefore, was to allow the claimant a breathing space of twelve months in which to establish a replacement franchisee and to protect its goodwill, free from competition, from a franchisee who had previously operated within the franchise territory. The fact that, in the event, the claimant did not seek to find a replacement franchisee in the months following the termination has no relevance. The meaning of the clause cannot depend on what happened after the contract was made. The judge’s interpretation pays no regard to the obvious commercial purpose to which I have just referred. On his interpretation, Clause 23.1(a) only prevents the defendant from competing during the twelve months’ period if there is a successor to the business actually trading within the territory during that period. But, as the authorities to which I have referred make clear, an important purpose served by restrictive covenants such as Clause 23.1(a) is to protect the franchisor’s goodwill and to protect its ability to find a replacement franchisee. On the judge’s interpretation the claimant is only entitled to the protection of its goodwill afforded by Clause 23.1(a) until it has found a replacement franchisee. Once that has occurred, an important purpose served by the clause has been achieved. It makes no sense to deny to the claimant the protection of the clause during a period when he really needs it, and to grant it during a period when its value to the claimant is limited to protecting its interest in seeing that the replacement franchisee prospers.

There are also real practical problems with the judge’s interpretation. First, as Mr Evans Tovey points out, if the clause does not bite until the replacement franchisee is appointed, then, unless the defendant monitors the situation regularly or the claimant informs him, the defendant will not know whether and when the clause starts to bite and when he should cease to trade. Secondly, on this interpretation, the new franchisee can begin trading at the start of the twelve months’ period. He may take a lease of premises for that purpose. He may take on the staff and incur other obligations. If, after he has been trading for, say, six months, the claimant appoints a successor to the business, the franchisee has to stop trading and cannot resume until the end of the twelve-month period. That would be most unfortunate for the franchisee and is an arrangement to which he is unlikely to have agreed. I would interpret the agreement as having that effect only if the language compelled me to do so. For the reasons that I have given, it does not compel such a conclusion.

I would therefore reject the judge’s interpretation and allow the appeal. I would propose that we hear argument as to the relief that should follow.

I agree.

I also agree.