Franchise 101: Call Option Claim Bends; and Small Business on Main Street

Franchisor 101: Call Option Claim Bends

A Delaware court found a yoga studio franchisee was entitled to an order requiring the franchisor to buy all of the franchisee’s yoga studios in six states. The court held the franchisor breached its contractual obligation owed to its franchisee. The failure to perform was not excused.

CorePower Yoga, LLC is a franchisor of yoga studios. It exercised the call option in the franchise agreement. This required its franchisee, Level 4 Yoga, LLC, to sell CorePower all its yoga studios operating in six states. The acquisition was stated in an asset purchase agreement (“APA”) signed in May 2019. The deal was to take place in three parts. The first part would close on April 1, 2020. As businesses began to shut down due to COVID-19, CorePower decided to delay or terminate the transaction, which the franchisee refused to do.

CorePower told all franchisees, including Level 4 Yoga, to temporarily close all studios due to COVID-19. On March 26, 2020, CorePower declared the APA was no longer valid because Level 4 Yoga repudiated the contract by closing its studios. CorePower pointed to the Material Adverse Effect (“MAE”) clause and the APA’s requirement that Level 4 Yoga continue to operate its yoga studios in the ordinary course of business. Level 4 Yoga sued CorePower for breach of the APA.

The court found Level 4 Yoga was contractually obligated to sell to CorePower and the parties structured the APA as a “one-way gate” without any closing conditions, termination rights or force majeure clause. Agreeing not to include such conditions in the APA showed the parties’ intent to close the transaction even if either party breached the APA. The court rejected CorePower’s arguments that its performance was excused because Level 4 Yoga repudiated or breached the contract, and that the APA’s purpose was frustrated. The court found Level 4 Yoga complied with CorePower’s direction to temporarily close its studios. Thus, Level 4 Yoga operated its yoga studios in the ordinary course of business when it closed them, as directed by CorePower and as mandated by state and local governments.

Franchisors should have experienced counsel advise and prepare contracts with provisions to protect the parties if a force majeure event or other circumstances make a previously negotiated deal untenable. Experienced franchise counsel can provide guidance early on when considering terms of call options in franchise agreements, and can advise on any subsequent negotiated purchase of a franchisee’s existing locations.

Franchisee 101: The Small Business on Main Street

A federal district court denied a motion for preliminary injunction brought by pizza franchisor, Breadeaux’s Pisa, LLC, seeking to stop a former franchisee from operating a competing pizza business.

The franchise agreement had a non-compete covenant prohibiting the franchisee from operating or owning an interest in a pizza business for two years after termination. Yet the franchisee continued to operate a pizza restaurant at the same location after termination of the franchise agreement, using the name “Main Street Pizza” and using the same phone number as the Breadeaux franchise.

The former franchisee eventually changed the phone number and deidentified the restaurant to no longer resemble Breadeaux. The franchisor demanded the ex-franchisee stop operating Main Street Pizza. The ex-franchisee continued operating. The franchisor sought a preliminary injunction ordering the former franchisee to stop operating Main Street Pizza and not operate any other pizza restaurant for two years.

The court ruled the franchisor failed to meet its burden for injunctive relief. For a preliminary injunction, the franchisor must show: (1) the threat of irreparable harm; (2) the balance between this harm and the injury that the injunction will inflict on other parties; (3) the probability the movant will succeed on the merits; and (4) public interest. The court concluded that the franchisor could not show sufficient threat of, or actual irreparable harm if the former franchisee continued to operate Main Street Pizza.

The franchisor argued the non-compete covenant established a threat of irreparable harm. The argument was that in the provision the former franchisee consented to entry of a preliminary injunction if it breached the non-compete covenant, and the former franchisee was clearly in breach. The court was not persuaded. The court found that language of a contract, standing alone, is not enough to require entry of injunctive relief, nor does such language, by itself, establish a threat of irreparable harm.

The court found that competition by the former franchisee would not result in irreparable harm to the franchisor. The nearest Breadeaux location was 75 miles from Main Street Pizza. It was unlikely the Main Street Pizza operation robbed the franchisor of Breadeaux customers. Further, there was no appreciable danger of damaging Breadeaux’s trademarks or goodwill since the former franchisee stopped using the Breadeaux name, branding, color scheme, and telephone number.

Franchise agreements often have non-compete covenants. Franchisees contemplating operating a competing business after leaving a franchise system should consult with franchise counsel to assess strength and enforceability of any non-compete clause in the franchise agreement. Enforceability of these covenants is often a challenge and depends largely on state law and language of the covenant.

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