USA – CALIFORNIA Law and Practice Contributed by: Dawn Newton and Hayley M. Lenahan, Donahue Fitzgerald
the franchised business and franchise assets, togeth - er with other damages caused by the violation, and injunctive relief may also be available (Section 20035). 6. Restrictions on Competition in Franchise Agreements 6.1 Treatment of Competition Restrictions in California imposes broad statutory restrictions on non-compete agreements. Business and Professions Code Section 16600 provides that contracts restrain - ing a person from engaging in a lawful profession, trade or business are void. The statutory exceptions are narrow and apply in connection with the sale of a business and its goodwill, the dissolution or dissocia - tion of a partnership, or the dissolution of or termina - tion of an interest in a limited liability company. Section 16600 also applies in the commercial context. In Ixchel Pharma , LLC v Biogen , Inc , 9 Cal 5th 1130 (2020), the California Supreme Court held that restraints between businesses are not automatically void but instead evaluated under the rule of reason. Under the rule of reason, courts consider the restraint’s actual effect on competition, including the parties’ market power, the scope of the restriction, and any legitimate business justifications for it. Accordingly, restrictions on a franchisee’s ability to compete during the term of a franchise agreement may be enforceable depending on their scope and overall effect on com - petition. However, in practice, franchisors are typically unsuccessful in enforcing any post-termination non- competition term against California franchisees. Territorial and Exclusive-Dealing Restrictions Franchise Agreements Non-Compete Restrictions California’s Cartwright Act prohibits agreements that unreasonably restrain trade. In the franchise context, restrictions such as exclusive territories, exclusive dealing arrangements and certain purchase require - ments are not unlawful simply because they limit how a franchisee may operate. Instead, the operative question is whether the restriction has a meaningful anti-competitive effect in the relevant market.
During the term of a franchise agreement, exclu - sive territories, and other restrictions on where or to whom a franchisee may sell, are generally permitted. These restrictions are typically evaluated under the rule of reason and are more likely to raise concerns where they substantially limit competition in the rel - evant market. The average franchise system will not encounter issues. Purchase Ties Franchise agreements may require franchisees to buy certain products or services from the franchisor, an affiliate or an approved supplier. These requirements are generally permissible, but they may raise antitrust concerns if the franchisor uses its market power to force the franchisee to buy a separate product or service as a condition of obtaining the franchise or another required product. 6.2 Exclusive Territories and Competing Businesses Franchisors are permitted to grant exclusive territories to California franchisees. A franchisor may restrict a franchisee from operating a competing business during the term of the franchise agreement. Although these terms are still subject to California’s restrictions on unreasonable restraints of trade, franchisors are typically permitted to enforce these in-term prohibitions in order to protect their brand. 6.3 Requiring Franchisees to Purchase Specific Goods and Services A franchisor may require a franchisee to purchase cer - tain products and services only from the franchisor or its nominated suppliers. 6.4 Channel Reservation A franchisor may reserve certain channels such as the internet to itself. 6.5 Vertical Agreement Block Exemptions California does not extend a block exemption for fran - chise agreements or other vertical agreements com - parable to the EU’s Vertical Agreement Block Exemp - tion Regulation, nor is there a procedure for obtaining a franchise-specific exemption. Vertical restraints are
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