Recently, the North American Securities Administrators Association, Inc.’s (“NASAA”) Franchise and Business Opportunities Project Group (“FPG”) issued guidance on post-term non-compete clauses in the context of the franchise business model (“Guidance”).
The FPG is a standing committee of NASAA comprised of state franchise examiners that study and makes recommendations to NASAA about model acts, statements of policy and commentaries with respect to franchise regulatory guidance. Guidance issued by the FPG is not law, but state examiners will often formally adopt or otherwise follow the direction of the FPG when regulating the offer and sale of franchises.
In its most recent guidance, the FPG formally recognized the utility of post-term non-competes in the franchise model so long as such provisions were reasonable.
This Guidance comes after two years of uncertainty at the federal level. In 2023, the Federal Trade Commission (“FTC”) issued a Request for Information seeking comments about the franchise model. The FTC received 5,200 comments and identified post-term non-compete clauses as one of the top concerns of franchisees. Then in 2024, the FTC banned non-competes in employment settings, sparking lawsuits questioning the authority of the FTC to enact such a ban. As a result, the FPG decided the time was ripe to provide its own Guidance on post-term non-competes.
In its Guidance, the FPG states that a reasonable post-term non-compete in franchise agreements requires “a balancing of scope, territorial or market reach, duration, and effect on the departing franchisee, weighing the interests of the franchisor, the existing franchisees in the system, and the franchisee exiting the system.”
- Scope. In analyzing the reasonableness of a non-compete scope, the FPG recommends a specific narrow description of prohibited activities that protects the franchisor while allowing the franchisee an opportunity to apply its experience to a new venture.
- Duration. The Guidance again recommends analyzing the realities of the market, including how long it will take to replace the franchisee, the status of the industry (innovative vs. mature), and other steps taken by the franchisor to protect the brand, in determining how long a post-term non-compete should last.
- Geography. For brick and mortar franchise concepts, a restriction around the unit location may be appropriate. For internet concepts, an analysis of where the customers originate may be helpful. Again, the Guidance provides a list of questions franchisors should ask when creating geographic non-compete prohibitions.
Franchise practitioners are anticipating a potential uptick in comments from state examiners scrutinizing the reasonableness of post-term non-competes during the franchise registration process. Franchise attorneys are recommending that franchise systems take a close look at these provisions to ensure they meet this standard. It is certainly possible that state franchise examiners will take a closer look at these provisions and issue additional comments to franchise system applicants this renewal season. Failure to anticipate such comments may delay the registration process.
It is important to keep in mind that most franchise lawyers already advise clients to impose only reasonable restrictive covenants in franchise agreements. This helps ensure such provisions will be upheld if ever challenged in court. This Guidance provides one more reason why franchise attorneys should always urge clients to craft narrow restrictions absolutely necessary to protect their business interests. However, what is deemed reasonable to a state examiner assigned to protect franchisees in their state may be very different than what is reasonable to a judge or arbitrator. Stay tuned while we see how this renewal season shapes up with this new NASAA Guidance.
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