L and P Holdings Limited v See Double U Holdings Limited HC Hamilton CP1/02

[2002] NZHC 185

IN THE HIGH COURT OF NEW ZEALAND
HAMILTON REGISTRY CP1/02

BETWEEN L & P HOLDINGS LIMITED
Plaintiff

AND SEE DOUBLE U HOLDINGS LIMITED
First Defendant

AND CHARLOTTE MARY-JANE WILLIAMS and STEVEN DAVID BLAKELEY
Second Defendant

Hearing: 7 March 2002

Counsel: M J Hammond for Plaintiff
P D Allan for Defendants

Judgment: 8 March 2002

JUDGMENT OF PANCKHURST J

Solicitors: Tompkins Wake, Hamilton for Plaintiff
David Becker & Co, Wellington for Defendants

Introduction:

[1] The parties are franchisor, franchisee and guarantors, respectively. In terms of the franchise arrangement the first defendant was to open and operate a retail outlet selling mother and baby-care products under the trade name “Zambiino”. After less than two months of operation disputes arose which resulted in the first defendant purporting to terminate the agreement. The plaintiff in this proceeding seeks an interim injunction to restrain the defendants from engaging in any similar business activity.

[2] The franchise agreement dated 25 October 2001 contained a “no competition” clause whereby the franchisee and the guarantors agreed for three years from the expiry of the agreement or its earlier termination not to engage in any business similar to the Zambiino franchise within New Zealand. The defendants oppose the grant of an interim injunction on grounds which I will detail shortly.

Background:

[3] L & P Holdings Limited (L & P) is a Hamilton-based company incorporated in April 2001 to operate as a franchisor. Laura Wheeler is a director of the company and with her husband is centrally involved in its management. L & P intends to franchise the operation of its Zambiino concept nationally. The products comprise mother and baby-care items, including clothing. Relationships have been established with suppliers in New Zealand and overseas. L & P acquires the product lines and supplies them to its franchisees at a margin. In addition retail sales result in a royalty payment to L & P.

[4] A comprehensive agreement covers the franchise relationship. A franchisee is required to establish business premises fitted out in conformity with the Zambiino style. This involves a distinctive colour scheme and use of the Zambiino name. The business operation must be in accord with the franchisor’s “system” which is defined in the agreement:

“means the Franchisor’s distinctive, unique and complete method, style and philosophy for the operation of the Business as set out in the Manual and Specifications, and provided for in this Agreement including without limitation, the Intellectual Property;”

The franchisee must purchase stock exclusively from the franchisor. To that end there is a manual which details the various product lines and their price.

[5] In early October 2001 the second defendants Ms Williams and Mr Blakeley saw an advertisement for the Zambiino franchise. They contacted Mrs Wheeler. Negotiations occurred over a few weeks, during which it is alleged various representations were made. In the result the franchise agreement was concluded on 25 October 2001.

[6] Pursuant to it Ms Williams and Mr Blakeley through their company, See Double U Holdings Limited (See Double), agreed to establish a Zambiino franchise in the Wellington area. L & P arranged the fitting out of premises in Molesworth Street in the Thorndon area of the city. The cost was about $112,000. The shop opened for business on 1 December 2001.

[7] By early January significant disputes had arisen between franchisor and franchisee. Ms Williams’ then concerns included non-payment of contractors who had assisted with the shop fit-out, and increases in the prices for stock. Relations did not improve. By letter dated 20 January 2002 Ms Williams indicated that termination of the agreement was in contemplation, unless Mrs Wheeler provided an amended price list containing reasonable figures. Ten days from 21 January was allowed to that end. Mrs Wheeler responded immediately indicating that prices would revert to those which applied under an old price list dated 1 December 2001. However, by a further letter dated 23 January 2002 Ms Williams gave “formal notification of termination” of the franchise agreement. Various grounds of termination were detailed.

[8] Mrs Wheeler immediately instructed her solicitors who responded in relation to the various complaints in the letter of termination. The letter concluded by noting that See Double had repudiated the contract which enabled L & P to cancel at its option, but that on a without prejudice basis the franchisee was invited to mediate the dispute.

[9] Such invitation was not taken up. Accordingly on 20 February this proceeding was issued.

The Respective Cases:

[10] By its statement of claim L & P seeks a permanent injunction in terms of the no competition clause in the agreement and, by a second cause of action damages of $12,000 for unpaid stock and $15,000 for goodwill. The latter is a fixed amount in terms of the agreement payable after two years or sooner in the event of termination. This cause of action is of no relevance to the present application.

[11] The terms of the injunction now sought are an order restraining See Double and the individual defendants from:

“(a) trading independently of the plaintiff

(b) using the Zambiino trademark and trading in Zambiino products independently of the plaintiff

(c) contacting the plaintiff’s suppliers (as defined in the franchise agreement)

(d) using the business system, as defined in the franchise agreement, independently of the plaintiff, and

(e) carrying on, engaging in or being interested in or concerned with a business similar to or in any way connected with the business carried on by the plaintiff within New Zealand.”

[12] By their notice of opposition the defendants assert that they have already ceased using the Zambiino trademark, signage, intellectual property, products, and its business system. Substantively they allege that they have a defence to the claim based on misrepresentations made by Mrs Wheeler which induced entry into the franchise agreement. It is also asserted that the balance is inclined against the grant of an interim injunction, since damages would be an adequate remedy (if the plaintiff were to succeed), irreparable harm would be caused to the defendants if an injunction were granted and because there is no legitimate interest of the plaintiff deserving protection pursuant to the restraint clause.

Serious Question to be Tried?:

[13] Mr Allan accepted, rightly in my view, that from the plaintiff’s perspective there was a serious question to be tried. This is obviously so since a franchise agreement entered into for an initial period of four years has been terminated, purportedly for cause, less than three months into its defined term. Moreover, the right of termination provided in the agreement is defined by clauses 88 and 89. These indicate that in the event of a breach the party not in default may require the other to remedy the default within fifteen business days failing which termination may follow.

[14] In fact Ms Williams purported to give notice to rectify a breach in her letter of 20 January 2002. The breach was delivery of a price list which contained increases she considered to be unreasonable, it being a term of the business relationship that increases would be kept within reasonable bounds. In the letter she said that she had contacted her solicitor and appreciated she was obliged to allow fifteen business days to rectify “not five business days as originally thought”. Therefore a further ten days from Monday, 21 January was allowed. In the event, however, See Double purported to terminate by its letter dated 23 January 2002.

[15] In these circumstances it is obviously arguable that the purported termination was procedurally deficient irrespective of the substantive rights and wrongs of the price dispute itself. To further compound matters the restraint clause is expressed to enure for three years “from the date on which this agreement expires or is sooner terminated”. Hence prima facie the defendants remain bound by it irrespective of the purported termination of the franchise agreement.

[16] In these circumstances it seems to me that whether there is a serious question to be tried is most to be assessed in relation to two issues raised on behalf of the defendants:

[a] whether they may arguably wholly avoid the franchise agreement on account of misrepresentation in terms of the Contractual Remedies Act 1979, or for deceptive or misleading conduct in terms of the Fair Trading Act 1986, and

[b] whether it is arguable L & P had no legitimate interest to protect such that the restraint of trade clause cannot stand.

I shall briefly consider these two aspects.

[17] The defendants contend that several actionable misrepresentations induced their entry into the agreement, or put another way that misleading conduct on the part of Mrs Wheeler had a similar result. The relevant complaints are set out in Ms Williams’ affidavit in opposition. They raise contested issues of fact which cannot be determined in the present context. Nonetheless it is appropriate to at least identify the competing contentions in order to assess whether the allegations of misrepresentation may be at least arguable.

[18] Ms Williams deposed that in the course of the pre-contractual negotiations Mrs Wheeler said that L & P imported 3,000 different product lines for supply to its franchisees. However, when a price list was provided it proved that only about 1,400 items were available from which stock selection could be made. In response Mrs Wheeler denied that she had asserted the availability of 3,000 lines “as changes and variations were constantly occurring and that was pointed out . . . by me”. Mr Allan argued this reply was not at all convincing since an advertisement for Zambiino productions contained the representation that Mr and Mrs Wheeler imported nearly 3,000 lines from all around the world from which franchisees could choose their stock.

[19] Ms Williams also maintains that she was misled in relation to exclusivity. That is that the stock supplied by L & P was only available to its franchisees, whereas it is now apparent that other retailers carry the same lines and, it is suggested, obtain them at better prices. She deposed to various brand names for which distribution rights were held by other companies. Very little stock, only five items, was produced by Zambiino Productions and bore that label.

[20] These assertions were not directly refuted by Mrs Wheeler. She stated that L & P sources stock lines on a world-wide basis with a focus upon the top end of the market. It is the company’s intention to manufacture an increased number of items in New Zealand bearing the Zambiino Productions label. Hence the factual situation is not in issue. Rather there is a contest as to whether exclusivity was asserted in the course of the pre-contractual negotiations.

[21] The defendants also allege that it was represented to them that the Zambiino franchise in Rotorua was “a complete success”. Ms Williams was told she could not speak to the Rotorua franchisee on account of a then dispute which would, however, be easily cleared up. Nor was it possible to obtain financial information pertaining to the Rotorua business as accounts were not available at that time, October 2001. Subsequently Ms Williams obtained information to the effect that by letter dated 5 October 2001 a solicitor acting for the Rotorua franchisee had purported to terminate the agreement for cause. This was before Mrs Wheeler described the franchise as a complete success to the second defendants. Also, Ms Williams deposed that the business had struggled to survive from the very beginning and was never a success.

[22] Mrs Wheeler disputed that the Rotorua franchise had been presented and described as suggested. She acknowledged there were problems in relation to the franchise which were still to be mediated. However she was adamant that nothing had been hidden in the course of the negotiations.

[23] A further factual dispute relates to whether Mrs Wheeler said a Zambiino Productions’ shop would be up and running in Hamilton before the end of 2001. According to Ms Williams such an assertion was made and it was of consequence to her because the existence of a third retail outlet represented progress towards establishment of a national presence, which would also bring economies of scale and related advantages.

[24] Mrs Wheeler acknowledged her intention to open a Zambiino Productions shop in Hamilton, but denied that she had said this would occur in 2001. She said that a lease was now in existence dated 1 March 2002. She did not depose as to when the shop may open for business.

[25] Finally, complaint was raised with reference to financial projections for the Wellington franchise obtained by Mr and Mrs Wheeler from accountants in October 2001, shortly before the franchise agreement was signed. The projections suggested, for example, that total sales of 58,000 could be achieved in December 2001, and annual sales to November 2002 of say $550,000. In fact See Double achieved a turnover of only $12,500 in December which led Ms Williams to suggest the projections were unrealistic and misleading.

[26] On the other hand it is common ground that the accountants proceeded on the assumption that the retail outlet in Wellington would be in Lambton Quay, not Thorndon. This according to Mrs Wheeler made the world of difference and explained the lesser result.

[27] To my mind it is only necessary to mention these competing contentions in order to demonstrate the extent to which the substantive merits are contentious. The alleged misrepresentations were largely oral. Rather than a conflict as to whether factual matters were mentioned at all, the dispute is as to context, extent and emphasis. In such circumstances it is quite impossible to form anything more than a general impression concerning whether actionable misrepresentations or misleading conduct may be made out.

[28] Nonetheless I consider that these allegations are at least arguable. They cannot be characterised as totally without substance. Issues of materiality, reliance, and the reasonableness of the defendants’ actions will also obviously arise. At this stage it would not be appropriate to speculate further as to the likely outcome.

[29] Principles relevant to the enforceability of restrictive covenants are well settled. The starting point is the general rule that restraints of trade are contrary to public policy and therefore void. But where the restraint is no wider than the circumstances of the case reasonably require and there is a legitimate interest to be protected, a covenant is enforceable. Covenants arising in the context of commercial transactions particularly where there is no imbalance of bargaining strength are more likely to be upheld than, for example, a restraint imposed in the context of an employment relationship. The reasonableness of a covenant is to be assessed with reference to the circumstances existing at the time the agreement was entered into. As to these principles see : Brown v Brown [1980] 1 NZLR 486 (CA) and Fletcher Aluminium v O’Sullivan [2001] 2 NZLR 731 (CA).

[30] To my mind the key question in relation to the present restraint clause is whether L & P can point to a legitimate interest which is in need of protection. The plaintiff considers that the Zambiino concept is indeed unique. That it has established a distinctive business system. Hence the agreement refers to the “system” in terms of method, style and philosophy as set out in the manual and specifications provided by the franchisor. At least on the basis of the affidavit evidence I have some difficulty in comprehending just what it is that constitutes the Zambiino business system. Certainly L & P has a proprietary interest in the Zambiino name, including the distinctive signage and colour scheme associated with it. But the actual business system is perhaps somewhat more elusive.

[31] Although not put in quite this way, it seemed to me that Mr Allan effectively argued that the business concept was illusory. He referred to the franchisee’s complaints that there was no exclusivity in relation to the product, nor in relation to the area of operation given that personal distributorships have also been sold by L & P. What remained was the business name and the aspects associated with its presentation. But a name alone, without exclusivity in relation to product and area of operation, did not constitute a viable business system.

[32] Again this is a matter which must await a substantive hearing. Nonetheless my impression at this interlocutory stage is that the plaintiff’s case is possibly less compelling with reference to the extent of its legitimate interest which is in need of protection by covenant. Conversely, the defendants may have a significant argument on this score.

Balance of Convenience:

[33] A number of the factors raised by counsel can be conveniently analysed under this heading. Mr Hammond argued strongly that damages would not be an adequate remedy for L & P. He contended that injunctive relief was a matter of commercial survival from the plaintiff’s perspective. The terms of the franchise agreement were clear. The parties were commercial entities who freely entered into that agreement. The reality, he suggested, was that the defendants having been set up in business now wished to “cut the plaintiff out of the commercial loop”. If they were not restrained from doing so the very essence of the franchise business which the plaintiff is in the process of establishing would be destroyed.

[34] On the other hand Mr Allan drew attention to the defendant company’s situation. It has leased retail premises for a term of two years and four months at an annual rental of $30,000 (exclusive of GST) or $2,500 per month. The lease includes a penalty provision whereby the tenant is required to keep the premises open for business from 9 am to 5 pm Monday to Friday, as a minimum. A breach of this requirement entitles the landlord to liquidated damages at the rate of $500 for the first hour and $100 for each subsequent hour of closure. The defendants are only permitted to use the premises for the sale of maternity and baby wear, and related products.

[35] Counsel resisted the suggestion that the defendants’ intention was to cut the plaintiff out of a successful commercial loop. Rather economic necessity forced the defendants to terminate the franchise agreement. Contrary to their expectations exclusivity was lacking, the cost of product supplied by the plaintiff was high and as a result the business was not viable. Were an injunction granted in the terms sought it would constitute a final judgment in the case, since the defendants would be unable to trade and the lease obligations would be ruinous.

[36] Which of these two extremes is closest to the truth will only emerge at trial. However the respective contentions do, I think, focus attention upon the breadth of the order sought by the plaintiff. In particular I see a distinction between restraining use of the Zambiino name and business system on the one hand, and restraint of trade generally on the other.

Overall Justice:

[37] I am satisfied that the overall justice of the case favours the grant of an interim injunction, but not on the terms sought by the plaintiff. In my view the appropriate course is to restrain the defendants’ use of : the Zambiino name/trademark, Zambiino labelled products and the Zambiino business system. Otherwise, I am not persuaded of the justice of an interim injunction in the terms sought by the plaintiff.

[38] This is not a case which concerns an established and durable franchise operation. To the contrary there is an issue as to the viability of the Zambiino business operation and system. It is not clear to me that the defendants have through entry into the franchise agreement obtained access to commercially sensitive information or materials in the form of a distinctive business system. I consider, therefore, that they should be restrained from any form of association with the Zambiino name but not further restricted with reference to their ability to trade. Beyond that the plaintiff must rely on damages to compensate, albeit their assessment may occasion difficulty. That difficulty is to my mind, however, outweighed by the dire consequences for the defendants if they were fully restrained in trade.

Result:

[39] An interim injunction will issue in the terms indicated above. It may be that an injunction in those terms could be permanent rather than interim in nature? I reserve leave for the parties to apply further with reference to the terms of the order.

[40] Costs are reserved. If counsel are unable to agree, the plaintiff may submit a memorandum within fourteen days and the defendants will have ten days within which to reply.

[41] I request that the Registrar place the case in an appropriate Duty Judge or Master’s list for mention, and in particular for a timetable to be set with reference to the substantive hearing.