Franchise 101: A Broad Brush Addendum; and Blown Dry by the Competition

Franchisor 101: A Broad Brush Addendum

A Virginia district court dismissed a lawsuit filed by 360 Painting, a franchisor of residential and commercial painting services, concluding an addendum to the parties’ franchise agreement precluded 360 Painting’s claims for breach of contract and equitable relief.

360 Painting and an individual franchisee entered into a franchise agreement, granting the franchisee the right to operate a 360 Painting franchise. The parties executed an addendum when signing the franchise agreement, waiving the parties’ rights to recover unpaid or future royalty or other fees owed post-termination.

Soon after the franchise agreement was signed, the franchisee formed a corporation, AASK Services, and began operating the franchised business under that entity, although the franchise agreement was never formally assigned to AASK Services. Ultimately, 360 Painting terminated the franchise agreement and filed suit against the individual franchisee and AASK.

360 Painting alleged it suffered damages, including lost royalties from breach of the agreement, the franchisee misappropriating 360 Painting’s trade secrets, and the Franchisee’s disparaging remarks on social media. The franchisee argued the addendum to the franchise agreement precluded 360 Painting’s right to damages, as both parties waived their right to recover post-termination royalties and fees. 360 Painting contended the addendum was unenforceable due to its reference to a non-existent section of the franchise agreement and that it only applied to the individual franchisee since it had not been executed by AASK.

The court found the parties intended to include the waiver provisions in the addendum, and the reference to a non-existent provision in the franchise agreement was typographical error. The court rejected 360 Painting’s argument that the addendum was only effective as to the individual owner of the franchise entity, noting the owner explicitly signed the franchise agreement and addendum in his individual capacity but intended to transition to a corporation soon after execution—the franchise entity commenced operations under the name AASK one week after the individual franchisee signed the franchise agreement and addendum. Although the franchise agreement and addendum had not been formally assigned or transferred to AASK, the court rejected 360 Painting’s assertion that the addendum did not apply to AASK.

Franchisors should work with franchise counsel to carefully structure their agreements and any addenda or amendments to the franchise agreement. Franchisors should understand if they are giving up a right, such as a right to recover damages, and the consequences of such provisions in their franchise agreements and addenda.

360 Painting, LLC v. Misiph, 2023 U.S. Dist. LEXIS 121493 (W.D. Va. July 13, 2023)

Franchisee 101: Blown Dry by the Competition

A Minnesota bankruptcy court granted Fantastic Sams a preliminary injunction against a former Fantastic Sams franchisee, finding the operation of four new hair salons by the former franchisee was prohibited by enforceable non-compete provisions in the parties’ franchise agreements.

Fantastic Sams entered into several franchise agreements with a franchisee for the operation of Fantastic Sams hair salons. The franchisee had solvency problems and closed two of its locations, ultimately filing for bankruptcy. As part of the bankruptcy proceeding, the franchisee requested that the court reject all of its franchise agreements, which the court agreed to do. The franchisee then began operating new hair salons at four of its prior locations under a different trademark. Fantastic Sams filed a motion for a preliminary injunction to stop the franchisee from operating the salons, arguing the franchisee’s operations violated the franchise agreements’ covenants not to compete.

The court concluded the post-termination covenants not to compete were enforceable. The court found the covenants not to compete reasonable in duration and geographic scope under Minnesota law. The franchisee could not operate a hair care business after termination of the parties’ business relationship for a period of two years from the date of termination, and within five miles of the original franchised salons or a 2.5 mile distance from any other Fantastic Sams franchise location.

The court found that “a franchisor has a just and honest purpose and a legitimate interest in protecting itself from the competition of a former franchisee operating in the same market,” and that non-competes in a business context are not disfavored and not against the public interest in Minnesota.

Franchisees should consult with counsel prior to operating a competing business after leaving a franchise system. A comprehensive review of the non-compete language in the franchise agreement, analysis of applicable law and consideration of whether to seek the franchisor’s consent to the competing business will save franchisees time and money, including defending against possible disputes by its former franchisor for breach of non-compete provisions.

EllDan Corp. v. Steele (In re EllDan Corp.), 2023 Bankr. LEXIS 1278 (Bankr. D. Minn. May 11, 2023)




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