Franchise 101: Competing With a Non-Compete Covenant; and Planet Interference
Franchisor 101: Competing With a Non-Compete Covenant?
A federal court in Louisiana granted a preliminary injunction against a former franchisee of Liberty Tax Service for breaching post-termination covenants under a franchise agreement.
Liberty Tax entered into franchise agreements (the “Franchise Agreements”) for two territories in Louisiana. Liberty Tax provided training in franchise operations, as well as marketing and its business systems. Liberty Tax provided access to and copies of its operations manual, customer lists and other trade secrets.
The Franchise Agreements had five-year terms. They included post-termination covenants not to compete or solicit Liberty Tax customers within 25 miles of each territory for two years following termination or expiration. The Franchise Agreements required the franchisee to return the operations manual, customer lists, and all customer tax returns, files, and records on termination or expiration.
Liberty Tax terminated the Franchise Agreements in April 2019. However, the franchisee continued to operate out of one of the locations, under the name “Tax Service”, solicited prior customers for tax preparation services, and did not return the operations manual. Liberty Tax filed a complaint in 2020, for injunctive relief and damages. The parties agreed the franchisee breached one of the Franchise Agreements by continuing to operate a tax service center in the territory and using Liberty Tax customer information, including its customer lists and operations manual.
At issue was whether the two years when the franchisee prepared tax returns in a manner prohibited by the Franchise Agreements, should be credited against the two-year post-termination covenant. The franchisee argued the convent expired in April 2021, two years after the agreements were terminated. Liberty Tax argued that Virginia law governed the dispute and allows equitable extension of post-termination covenants relating to non-competition and non-solicitation. Liberty Tax argued for a two-year restriction from the date any injunctive order was issued by the court.
The court found that despite almost two years passing between termination of the Franchise Agreements and filing the complaint, Liberty Tax was entitled to a preliminary injunction. The court explained that to decline to extend the covenants an additional two years, as allowed under Virginia law, from the date of the injunctive order would reward the franchisee for breach. The court did, however, reduce the extension from two years to 20 months, because Liberty Tax waited four months after discovering the breach to file the complaint. Breaches of post-termination covenants are a common issue for franchisors. Franchise counsel can advise franchisors how state law can affect interpretation and enforcement of such covenants and recommend courses of action.
Franchisee 101: Planet Interference
A federal court in New Hampshire found a multi-unit operator of five Planet Fitness gyms plausibly alleged the franchisor interfered with its business relationships and denied Planet Fitness’ motion for judgment on the pleadings.
JEG-United (“JEG”) alleged it entered into a letter agreement with Planet Fitness, in which they agreed to negotiate an agreement giving JEG the opportunity to establish Planet Fitness gyms in Mexico. If the parties reached an agreement, separate franchise agreements would govern each additional location.
JEG claimed Planet Fitness interfered with three transactions to develop additional gyms: (1) Planet Fitness instructed a retail company with whom JEG had a preexisting landlord-tenant relationship, to stop working with JEG in creating a portfolio of potential locations; (2) Planet Fitness attempted to convince a potential buyer of JEG’s gyms that Planet Fitness would sell gyms to them on better terms; and (3) Planet Fitness interfered with JEG’s negotiations to buy competing gyms and convert them to Planet Fitness gyms, to expand Planet Fitness’ growth in Mexico.
In response to each alleged interference, Planet Fitness argued it would have been a necessary party to any future franchise agreement and would have the right to pre-approve new locations.
The court disagreed, finding JEG had a plausible claim for interference in each of the three instances. While Planet Fitness would be a party to any future franchise agreement and could later refuse to grant franchise contracts to JEG, the franchise relationship between Planet Fitness and JEG did not make Planet Fitness a party to contracts, agreements, and negotiations between JEG and third parties. Multi-unit developers’ duties typically include negotiating with landlords and vendors to develop franchised locations. While a franchisor seeks to control and protect its brand in connection with potential locations and agreements, its options to inject itself directly in a developer’s third-party dealings may be limited. A franchisor may be subject to tortious interference, breach of the implied covenant of good faith and fair dealing, and related claims.